June 4 (Bloomberg) — Options on stocks and currencies show “strong warning signals” that the recent rally for both may be poised to end, Citigroup Inc. said.
The VIX, which tracks the cost of using options as insurance against declines in the Standard & Poor’s 500 Index, has risen even as equities trade near seven-month highs, according to New York-based Citigroup. Currency options show traders betting on wider exchange-rate swings, indicating investors may shift away from the higher-yielding assets that benefited from signs of an economic recovery, the bank said.
“We are seeing a disconnect between what’s happening on implied volatility and underlying price action across a host of markets,” Citigroup chief technical analyst Tom Fitzpatrick in New York and strategist Shyam Devani in London wrote yesterday. “It suggests to us a real danger that a good consolidation/ correction to a lot of recent trends may be near.”
The S&P 500 closed at a seven-month high of 944.74 on June 2 and slipped to 931.76 yesterday. The gauge has recouped 38 percent since March 9 on speculation $12.8 trillion pledged by the government and Federal Reserve will help end the recession. The VIX, a gauge of expected swings over the next 30 days, is up 7.7 percent at 31.02 from its eight-month low on May 19. The measure hasn’t closed above 34.50 since May 4.
The VIX, as the Chicago Board Options Exchange Volatility Index is known, may re-test the 34.50 level from a month ago, which would suggest “danger of a pullback” for the S&P 500, Citigroup said.
“Our fear is that complacency is back in the market and the low volatility has fueled a lot of these moves,” the strategists wrote. “This pick-up in volatility seems to be warning that nothing is one-way forever and when you start to believe that it is when you get hurt.”
Three-month implied volatility on euro-dollar options, a measure of risk in foreign-exchange investments, rose for a fifth day to 16 percent on June 3, the highest in eight weeks. The dollar rallied against the European currency in December and March after “sharp bounces” in volatility, Citigroup said.
The 30-day correlation coefficient between euro-dollar and the MSCI World Index peaked in November at 0.737 as the benchmark gauge for global stocks fell to a five-year low, data compiled by Bloomberg show. The correlation weakened as stocks rose at the end of the year, only to reassert itself in February and March as the MSCI dropped to the lowest since 1995.
A correlation of 1 would mean the euro and the stock index moved in lockstep.