By Gertrude Chavez-Dreyfuss
NEW YORK, Sept 15 (Reuters) - Riskier markets have been riding high for several months on hopes for economic recovery, but both currency and equity options markets reflect worry that the rebound will be short-lived.
Stocks and other risk assets have surged since March as indicators suggested the global recession was abating. The S&P 500 has risen 57 percent from its March low, while higher-yielding currencies associated with increased risk appetite such as the Australian and New Zealand dollars have surged more than 20 percent this year.
But prices on options in stocks and currencies suggest investors are taking cover, looking ahead to wilder swings and lower asset prices, because of fears that the recovery, underpinned by government stimulus, will be fleeting.
Joseph Mezrich, head of U.S. quantitative research at Nomura Securities in New York, said volatility measures may now be pricing the "dreaded W-shaped recovery," which indicates another fall-off in economic activity before long.
Key volatility indicators in options markets suggest investors are somewhat worried about near-term prospects, but more concerned about what lies several months down the road.
One important measure, implied volatility premiums on call options, also known as the call skew, illustrates this.
The call skew is determined by looking at the difference in cost between at-the-money (ATM) and out-of-the-money (OTM) call options, and usually reveals the market's attitude about future expectations. Call options are a bet that an asset will rise.
Data from Nomura Securities showed that the 30-day implied volatility premium surged to a reading of 2.1 percent late on Monday from 1.5 percent nearly four weeks ago, while the one-year vol premium increased to 3.7 percent from 3.5.
Out-of-the-money call options cost less than ATM options because they represent a bet that the underlying asset will rise to a level not yet attained, which may not happen by the time the option expires. The greater the gap between the price of the OTM call and the ATM call -- that is, the higher the premium -- the less optimistic investors are about stocks.
"Since late June, the stock market has been straight up without any kind of sustained pullback and people keep thinking 'It can't be this good,'" said Kevin Fischer, an options trader at Interactive Brokers in Greenwich, Connecticut. "It has to pull back and it hasn't yet. And the longer you go straight, the harder the drop is going to be when it comes."
MORE BEARISHNESS DOWN THE ROAD
Analysts also compare the difference between the implied volatility premium of options expiring in 30 days and those expiring in one year to gauge near- and long-term market optimism.
In mid-August, the spread in implied vol premiums between 30-day and one-year S&P 500 call options had widened to 2 percent, the largest skew dating back to 1996, when Nomura first started compiling this data. That 2 percent spread meant the market was more optimistic about the near-term than the one-year outlook.
That has changed over the last few days, Nomura's Mezrich said, with the spread at a high 1.6 percent, showing the market is still cautious about both the short and long term outlook.
The U.S. government's stimulus money has helped the stock market. But Interactive Brokers' Fischer said when stimulus money runs out or foreign central banks raise interest rates, the dollar could come under more pressure and stocks could take a hit as well.
"No one knows when this is going to happen, but the market knows it will happen," Fischer said.
FEAR IN CURRENCY OPTIONS
Just as stock options suggest concern, similar worries can be gleaned by looking at volatility curves in the currency options market.
Economic performance and currency volatility prices have generally moved in opposite directions since 2001, establishing a generally stable link. The lower the vol, the more comfortable investors are with global prospects for growth.
"Steepening volatility curves, with weaker one-month prices but firmer six-month vol prices warn of rising FX volatility and risk aversion into the year-end," said Simon Smollett, currency options strategist at Calyon in London.
The one-month implied volatility for euro/dollar was 10.45 percent on Tuesday, down from 15.82 percent in early March, when the S&P 500 hit a 12-year low. Vols measure how much investors expect a currency to move in either direction over a given time frame.
Euro/dollar six-month vols, meanwhile, were 12.02 percent on Tuesday, roughly 15 percent higher than one-month implied prices, while one-year vols were also elevated, trading at 12.29 percent, reflecting increased nervousness going forward.
The global economy has improved from mid-September last year, when U.S. investment bank Lehman Brothers collapsed. But investors are still nervous about shaky areas of the economy, such as real estate.
"The decline in ... this gigantic market, which is tightly tied to the health of the insurance companies and all but the largest commercial banks, has just begun," said FX Concepts Chairman John Taylor, who runs a $12 billion currency hedge fund in New York. (Editing by Dan Grebler)