Consider Options

From Bloomberg:

Buy Options as Lower VIX Belies Risk

U.S. stocks rallying amid the narrowest swings in three years have pushed the VIX down to a level that makes options attractive as a cheap hedge against losses, according to Macro Risk Advisors LLC.

While there are economic risks that might otherwise drive up the cost of buying options as insurance, the VIX is being dragged down by one of the lowest Standard & Poor’s 500 Index volatility levels in four years, said Macro Risk President Dean Curnutt. That means stock investors should buy options because their prices are poised to rebound next year on renewed concern about European government debt, according to Curnutt, who predicted the region’s credit crisis.

Systemic risk is still very much active in the market,” Curnutt said in an interview. “The sovereign risk issue is almost guaranteed to flare up again in 2011.”

Demand for options to protect stocks is waning after the S&P 500 rose above its level on Sept. 12, 2008, before Lehman Brothers Holdings Inc.’s bankruptcy prompted a 46 percent plunge in the stock index through March 2009. The VIX, as the Chicago Board Options Exchange Volatility Index is known, fell to a three-year low yesterday as the benchmark gauge for U.S. stocks moved in its narrowest intraday range since April 2007.

Portugal Downgraded

Fitch Ratings said today that it downgraded Portugal’s long-term foreign and local currency issuer default ratings to A+ from AA- and short-term foreign currency rating to F1 from F1+. Greece may have its credit rating cut to non-investment grade within six weeks after a review of the nation’s “fiscal sustainability,” the agency said Dec. 21.

A VIX of 16 doesn’t even come close to reflecting just how serious the European sovereign debt crisis is,” Curnutt said. “To put this in context, when the VIX closed below 16 on April 14, the average credit-default swap level across Portugal, Ireland, Greece and Spain was 220 basis points. That same spread now is nearly three times that.”

Our friends in Portugal continue to suffer the long term consequences of government overspending.  As the national debt rose, the bond market began to react by demanding increased bond yields.  This phenomenon increases costs to borrow money for business and the general public.
As anyone who is familiar with capitalization rates knows, this is highly deflationary move, and has very negative effects on real estate, bonds and stocks.
While these higher credit default swaps have not yet come to America in earnest, the long bond has turned and its yields are rising rapidly.
We can expect VIX to bottom out very soon as the contagion in Europe spreads and infects markets throughout the developed world.
Note what has happened with the yield of 10 year Portuguese bond yields over the past 6 months:


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