European stocks have become fertile ground for savvy traders playing alternative strategies to make a buck in a rangebound market where long-term investors, spooked by a surge in volatility, sit on the sidelines.
Index trackers, equity derivatives, highly-leveraged contracts for difference (CFD), short-selling and algorithmic programmes are drawing more interest from traders and investors willing to play short-term moves while European markets are in the grip of the sovereign debt crisis.
The time when a fund managers' job was to beat the benchmark is over, said Romain Boscher, global head of equities at Amundi.
We are probably in for another good 10 years of rangebound stock markets, and investors cannot afford to be passive anymore. Clients want absolute performance, not relative performance.
Boscher recommends the use of put and call options to protect stock portfolios from violent drops. The idea is to catch the rallies but limit your exposure to the pull-backs.
Other market players feeling antsy in the sideways market go one step further, playing option straddles to benefit from the high volatility, regardless of the market direction.
A straddle is an options strategy in which an investor holds a position in both a call and put with the same strike price and expiration date. The strategy is used to capture the volatility by investors who think the underlying stock or index will move sharply, but are unsure about the direction.
Options, traded as puts and calls, allow investors to trade moves in share prices without owning the underlying stock.
RISING APPETITE FOR VOLATILITY-TRACKING ETFS
Straddles are for real pros, not for mom and pops, said David Thebault, head of quantitative sales trading, at Global Equities.
A lot of institutional investors will rather turn to exchange-traded funds (ETFs) tracking volatility, it's just simpler. I personally prefer put and call spreads, put with tight stop losses so you don't get burned if the market moves into the wrong direction.
To play a put or call spread, an investor buys put or call options at a specific strike price while also selling the same number of puts or calls at a lower strike price, a way to capture market movements without buying and selling stocks.
European ETFs -- a fast-growing market dominated by funds from Deutsche Bank
CFDs are a type of derivative replicating virtually any kind of financial asset and are used by investors to speculate on the underlying market's move. They also thrive when volatility jumps and traders use high leverage to amplify their gains.
Our clients have been heavily short on the euro lately, so you see a lot of smiley faces around, said Derek Lawless, head of WorldSpreads France.
CFD providers, which mainly target retail investors, offer a leverage of about 10 times on equity trading and about 100 times on currency trading.
The CAC 40 <.FCHI> is trading at 3,000 points. A decade ago, it was trading at 7,000 points. People are getting sick of 'buy and hold' strategies and long-only funds charging all sorts of fees, Lawless said.
LONG/SHORT STRATEGIES IN VOGUE
Derivatives are not the only way to play the range-bound market, however.
Stock pickers can turn to something known as a pairs trade, a market neutral strategy which matches a long position with a short position in two stocks of the same sector.
The pairs trade creates a hedge against the overall market as the investor bets solely on the gap between the performance of the two stocks.
But combined with PSA Peugeot
The bottom line is: 'long-term investment' used to mean 'five years'. It became 'three weeks' in 2010, and now it's 'three days'. No wonder why passive investors are getting smacked, Global Equities's Thebault said.
(Reporting by Blaise Robinson. Editing by Jane Merriman)