Published July 10, 2013
Investors seeking to predict the magnitude of share price moves at times of market flux may get a faulty steer from a closely watched "fear gauge", one of investment banking's top equity traders has warned.
Citi's <C.N> Mike Pringle, global head of equity trading at the third-biggest U.S. bank, told Reuters that the VIX volatility index <.VIX>, is now as much a traded asset as it is a guide to investors seeking protection from losses.
The VIX reflects Standard & Poor's 500 <.SPX> options prices and, therefore, expectations of future market moves. The idea is that as people become fearful of losing their money, they are more willing to buy a put option as protection.
At the moment, it remains at very low levels.
"A big mistake the market makes is looking at the VIX as an indicator of stock market risk. Why? Because it's an asset class and it's more traded for yield than protection," Pringle said.
"The growth of structured products around VIX drove that move. In most cases, the VIX is sold to generate yield but during some stress periods, the weakness in the spot level triggers significant computer-generated technical buying from these products," he said.
The VIX is widely followed as an indicator of investor sentiment, although there has long been debate over its efficacy as more financial instruments are derived from it.
"It's still relevant in extremes, but not in a normal functioning market," Pringle said.
Pringle cited Citi trading strategy research showing tens of billions of dollars' worth of assets under management linked to the VIX through structured notes, which had to be rebalanced to reflect actual market moves. This dampened volatility, he said.
The Citi data showed these VIX-related contracts make up about 34 percent of overall volatility trading on the S&P 500 and as much as 44 percent of the short-term, 2-month volatility.
The VIX rose nearly 80 percent in three weeks after the Fed hinted in late May at "tapering" its stimulus, albeit from a low starting point. It has since given back almost half the gains.
At levels around 15, it is currently below its average of just over 20, nearly half the 2012 high of 28 and well off the 2011 high of 48 and all-time high of nearly 90.
COMPUTERS DRIVING VOLUMES
While persuading others of the VIX's flaws is not easy, Pringle said Citi's handling of risk management in equities had been restructured accordingly.
Rather than relying solely on the VIX, Citi traders and clients can turn to the Central Risk Desk, through which a large proportion of its trades are routed.
The computer programs that underpin the desk's activities assess around 60 measures of market stress and timing - from global risk arbitrage spreads to dividends to repo rates - to get a better read on sentiment, behavior and deal timing.
Looked through this prism, there is greater risk currently in global markets than the narrower VIX is suggesting.
"Basically every 'fear factor' you could possibly get your hands on," Pringle said. Such a move had helped the bank be more efficient and grab 2 percent of market share in Europe, the Middle East and Africa last year, he said.
Market uncertainty has contributed to lower volumes, but Pringle saw them rising soon, though not to pre-crisis highs.
"We don't think volumes (in Europe) will ever get back where they were. At its highs the Euro STOXX 50 <.STOXX50E> daily volume was three times what it is now, 25 billion euros a day; it currently trades 8," Pringle said.
Those highs, fuelled by hedge fund leverage and investment banks trading on their own account aren't repeatable, Pringle said, although volumes could "definitely increase 30-40 percent by the end of the year and into the early part of 2014".
The number of shares traded daily in the Euro STOXX 50 index of euro zone blue-chip companies has ranged between 115 million and 345 million so far in 2013, against a 2008 peak of 778 million, Thomson Reuters data showed.
He expected volumes to be pushed higher partly by money from the east coast of the United States re-entering Europe.
"Pre-2008, around 10 percent of the (assets under management) internationally was invested in European equities. That's now sub-1 for the last four years. Europe won't take off until those people come back."
Pringle, though, said he was seeing signs of movement from that segment of the U.S. investment community, which remains the largest foreign investor in European shares.
"2013 is the first time that I've seen international investors coming to Europe for what you'd call 'value'," he said, referring to companies that are cheaper than peers, an out-of-favor investment play during the years of crisis.