Option lets traders put money on worst fears

The Insider

Your Money Your Money

April 25, 2004|By BILL BARNHART

AFTER an exhaustive study, Allen Poteshman, a professor of finance at the University of Illinois, has confirmed news reports shortly after Sept. 11, 2001:

Trading in options on airline stocks AMR and UAL indicates that someone profited from advance word of the terrorist attacks.

"There is evidence of unusual option market activity in the days leading up to Sept. 11," Poteshman writes in a paper posted on the Internet that goes deeper than the initial reports.

Obviously, authorities missed the market signal. The 9/11 Commission might want to look into the matter.

The urge to bet on or insure against major economic calamities has become a preoccupation on Wall Street. To reconstruct the words of Franklin D. Roosevelt, "We have nothing to trade but fear itself."

Last week, better-than-expected quarterly corporate reports and outlooks and upbeat economic news took a back seat to peculiar fears about an obvious fact: An expanding economy is likely to mean higher interest rates. Who knew?

The stock market looks forward, to be sure, but the week's action suggested traders weren't looking at indications that corporate profit growth is more sustainable than had been thought.

According to data from Goldman Sachs, the tendency of the stock market to trade as a unit, not as a collection of individual stocks, is increasing this year after declining last year.

Such macro trading can be bad news for stock pickers. An increasing number of hedge funds and institutional traders are betting on interest rates and market volatility, not on intrinsic values of discrete companies.

"In the derivatives market, volatility is the name of the game," said Joseph Levin, head of research at the Chicago Board Options Exchange.

The stock market has been calm for the past 12 months, despite the situation in Iraq. On Friday, an index of market volatility tracked at the options exchange, called VIX, reached its lowest level in nearly eight years.

You can sense frustration among volatility traders, which helps explain the current melodrama over textbook interest rate issues. Much of this trading has been in the private over-the-counter market, through deals among financial institutions.

Last month, the CBOE introduced a VIX futures market that, if successful, will shine public light on the business.

The VIX is derived from prices on options - puts and calls - on the Standard & Poor's 500 index, the benchmark for the U.S stock market. The options market is the place where those who think they have exclusive information go to make a quick buck.

The VIX index has been a widely followed indicator of market anxiety since 1993 but has not traded. Now traders can put money directly and conveniently behind market fears such as Nasdaq bubbles, terrorist attacks or Alan Greenspan.

Noting the current low level of the VIX, finance professor Robert Shiller of Yale University, author of Irrational Exuberance, said, "The timing is bad."

He added, however, that "what I like about it is it's such a fundamental and important thing to be trading. People might start using it to hedge against dramatic events."

Trading fear is one way of reducing fear.

Bill Barnhart is a financial columnist for the Chicago Tribune, a Tribune Publishing newspaper. E-mail him at yourmoney@tribune.com.

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