June 13, 2013 / 10:34 PM / 5 years ago

Option players step up portfolio insurance in emerging market ETFs

(Reuters) - Many participants in the U.S. options market appear to be stepping up their portfolio insurance in some international exchange-traded funds to offset concerns about the short-term outlook for global markets.

Strategists have noticed increased buying activity in downside puts in ETFs covering emerging markets as those markets have dropped substantially in recent weeks.

“We have seen a lot of weakness in the emerging markets and the heavy put buying suggests traders are hedging themselves for potential continued trouble in global markets over the next few months,” said Ryan Detrick, senior technical strategist at options research firm Schaeffer’s Investment Research.

Traders often use options in ETFs as part of strategies and hedging techniques to protect stock positions.

The put activity has been most active in the iShares MSCI Emerging Markets fund (EEM.P) and Vanguard FTSE Emerging Markets fund (VWO.P), given the weak emerging markets.

Both funds have both lost nearly 10 percent since May 8.

“We do sense that a higher level of concern has entered global markets,” said Alec Levine, equity derivatives strategist at Newedge Group SA in New York.

Stock markets in China, Australia and Brazil have all fallen sharply since mid-May as investors worry about reduced support worldwide from central banks and China’s economic growth.

“One of the problems is that in the Asia-Pacific region, there is insufficient demand for commodities from China, causing adjustments from Australia and Brazil,” said Jared Woodard, a principal of options research firm Condor Options in Forest, Virginia.

Newedge’s Levine noted investors have been buying puts and put spreads on the EEM, VWO and iShares FTSE/Xinhua China 25 Index fund (FXI.P) over the past month due to the slowdown in emerging markets economies, notably China.

    Overall volume on the EEM fund on Thursday was 2.5 times the daily average, with 658,000 puts and 210,000 calls changing hands, according to options analytics firm Trade Alert. Part of that turnover was driven by a large put trade as an investor braced for additional losses in the emerging markets.

    During the session, the August $37-$39 put spread on the EEM traded 235,379 times for a total net premium of 68 cents. The investor sold August $39 puts at a profit and rolled the position to buy lower strike August $37 strike puts, looking for a move below $37 in the fund by expiration, said Frederic Ruffy. WhatsTrading.com options strategist.

    “Big block buyers have been active in June, July and August downside puts in the two ETFs since late May and reaping substantial profits amid increasing volatility across global financial markets,” Ruffy said.

    Over the past 10 trading days, 3.53 puts have traded for every one call in the EEM fund as a new position on three U.S. options exchanges, data from Schaeffer’s Investment Research shows.

    What is even more significant is that the open interest on the VWO fund shows 218,650 puts compared with 15,141 calls, resulting in a ratio of 14.44 puts for every one call outstanding for near-term option expirations, Detrick said.

    Shares of the EEM, which tracks the equity performance of emerging markets such as Brazil, Russia, India and China, rose 2.09 percent to end at $39.93. The VWO fund closed 2.30 percent higher at $40.37.

    Reporting by Doris Frankel in Chicago; Editing by Dan Grebler

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