(This Feb. 4 story was refiled to change name to Garnry in 15th and 17th paragraph, clarifies designation in 15th paragraph)
By Saikat Chatterjee and Danilo Masoni
LONDON (Reuters) - Unnerved by the sabre-rattling between Russia and the West over Ukraine, traders are scouring global markets for investments that could provide them with protection against losses in case the conflict escalates.
Any conflict risks triggering a rout in riskier investments such as global stocks and a rush into so-called safe havens such as government bonds, gold and currencies like the U.S. dollar and yen, leaving those exposed to equities with large losses.
Typically, investors hedge against potential losses by buying assets that would pay out if the situation reverses, such as derivatives that could profit from a fall in stocks or commodities.
But with markets already gyrating in the face of rising inflation, worries about global growth and tighter monetary policy, the cost of that protection has gone up sharply in recent days, according to five traders.
Europe's equivalent of Wall Street's fear gauge -- an index which calculates how volatile investors expect stocks to behave in the short term -- is currently trading more than 50% above its 2021 average, indicating how increased demand is pushing hedging costs up.
Investors are having to peer deeper and farther across markets for ideas that offer affordable protection.
In interviews, traders and investors said they are looking at a range of strategies, from derivative bets on how wildly French stocks will gyrate or how much German stocks will fall to simply looking for assets that are currently out of favour but would benefit if markets got worse.
Two traders at major global banks, who requested anonymity because they were not authorized to speak to the press, said they are recommending their clients look at the French stock market and place derivative bets on volatility, a measure of the intensity of market swings.
Their expectation is that volatility in French stocks will increase in the event of a conflict because it is one of the most liquid markets in Europe.
One of the traders, who heads derivatives strategies at a top bank in London, is recommending that his clients buy call options on French stock market volatility, which would allow them to buy the underlying financial asset at a fixed price even as it rises in the event of a conflict.
To defray some of the cost of such a bet, the trader is telling clients to sell options on U.S. stock market volatility, which he thinks is likely to be less impacted by any escalation of the conflict. Taking such a two-pronged bet would, however, also reduce some of the profits should a conflict ensue.
Swiss bank UBS is recommending buying call options on the yen or the U.S. dollar, according to a note published this week. The two currencies would likely strengthen as investors seek out safe havens in the case of a conflict, making the bets profitable.
Another suggestion from UBS is to buy put options on German stock benchmarks, a bet that will pay out if the market falls. That is a possibility because of the reliance of German companies on Russian energy for production.
Some investors appear to be taking up that idea. A March 2022 DAX index put option, which would become profitable if the German index were to fall 10% below Wednesday's closing levels, saw record volumes on Jan. 24 and again on Wednesday.
ENDURING APPEAL OF GOLD The upfront costs of protection against what many still see as an unlikely event are leaving some investors reluctant to hedge, said Peter Garnry, head of equity strategy at Saxo Bank.
Investment houses like Amundi, for example, assign only a 10% probability of a full-fledged invasion.
Garnry recommends a different type of bet -- purchasing listed market-making firms like Virtu Financial and Flow Traders NV, which benefit when market volatility rises and the difference between the asking and the offering price of a security, called the bid-ask spread, increases.
Some like Sumit Kendurkar, a trader at market maker Optiver in Amsterdam say there is also interest in buying upside calls on options in energy stocks exposed to both natural gas and oil. UBS estimates that Russia and Ukraine combined account for nearly 20% of global gas and oil supplies. Roberto Lottici, fund manager at Banca Ifigest in Milan, has a straightforward old-school strategy of going for gold, doubling the size of gold and silver investments to 6% of his fund, while cutting put options and other hedging instruments that are becoming expensive.
“If the situation spirals out of control," Lottici said, "then it's going to be one of the very few assets that can offer protection.”