Callie Bost New York
THE GUESSING game over when the US Federal Reserve will raise interest rates is underpinning bets for more volatility across shares of banks, brokerages and insurers.
Traders are buying up options that pay off if the industry slumps, and now own 2.2 puts for each call on the Financial Select Sector SPDR Fund – the most in almost a year. The exchange-traded fund, which trades under the ticker code XLF, counts Wells Fargo, Berkshire Hathaway and JPMorgan Chase among its top holdings.
The cost of one-month bearish contracts is above the five-year average relative to bullish ones and puts make up nine of the top 10 options with the highest ownership, data show.
Investors are analysing economic data for signs of inflation and improvement in the labour market that may lead the Fed to increase borrowing costs sooner.
In June policymakers forecast they would raise the Fed funds rate above zero next year, without being specific. While higher interest rates may increase bank profit margins on loans and returns from new investments, it can hurt earnings if borrowing costs rise before the loan yields increase.
“People who own financials are getting nervous,” TD Ameritrade chief strategist Joe Kinahan said. “With so much uncertainty around interest rates, financials could be affected in a big way. If we’re in this limbo land for a while, some of those stocks will suffer.”
The first increase in the Fed funds rate will probably be in the third quarter of next year, according to the median economist forecast from a survey.
Vague forecasts from central bank leaders and mixed economic data have made it difficult for investors to gauge when rates will rise. Last month the Federal Open Market Committee repeated that the central bank would probably keep interest rates low for a “considerable time” after ending bond purchases.
Fed chairwoman Janet Yellen reminded investors in her testimony to Congress last month that if labour markets improved more rapidly than the committee expected, increases in the federal funds rate would probably occur “sooner and be more rapid than currently envisioned”. While her view of the economy had turned “more positive”, she was concerned about low participation in the labour force and sluggish wage growth.
At the same time, US gross domestic product expanded 4 percent last quarter amid a rebound in consumer spending and business investment. When the report was published on July 30, traders exchanged the most bearish contracts on the XLF fund in more than seven years relative to bullish ones, data showed.
Options protecting against a 10 percent drop in the fund cost 10.4 points more than calls betting on a 10 percent rise, according to one-month data. That is above the 9.3 point average for the price relationship known as skew since 2009.
Puts with a strike price of $21 and $19 that expire at the end of the week have the highest ownership. The exchange-traded fund rose 0.1 percent to $22.40 on Monday.
“There’s just tons of bearish activity,” Mark Sebastian, the founder of consultancy Option Pit, said. “There’s a lot of things up in the air between now and the October, November time frame for these stocks.”
The conflict between Ukraine and Russia, Israel’s strikes against Gaza and concern that the turmoil is hurting Europe’s economy has increased the turbulence across global equity markets. The Chicago Board of Trade options exchange volatility index has jumped 38 percent since reaching a seven-year low on July 3.
Bigger price swings might lead to higher trading volumes and support profits for banks and brokerages, Julian Emanuel, a US equity and derivatives strategist with UBS Securities, said in a note last week.
An average of 6.1 billion shares have changed hands on US exchanges this month, compared with 5.7 billion last month, data show.
“We are buyers of large-cap financials on further weakness as this group will benefit from more volatility,” Emanuel said.
Low interest rates have crimped banks’ profitability. Net interest margin, the difference between what a firm pays on deposits and charges for loans, was a record-low 3.1 percentage points last quarter, according to St Louis Fed data.
Other investors are less bullish. About $230 million was pulled from the XLF last week, the fund’s seventh week of withdrawals out of eight.
The fund is up 50 percent in the past two years. The Standard & Poor’s 500 index has rallied 38 percent in that time.
“The more volatility you get in the market, the more people are going to take money out of the financials,” Matt McCormick, a vice-president and portfolio manager at Bahl & Gaynor, said. “They’ve had a good run. For the most part, the news has looked okay, but the news going forward looks choppy.” – Bloomberg