In Draghi they trust as Europe stocks tempt bulls again: Options

Options traders and investors are rediscovering their taste for European stocks.

Mario Draghi and his European Central Bank colleagues may move a step closer to full-scale quantitative easing when they meet tomorrow in Frankfurt. That hope spurred investors to send money to a fund tracking the region’s equities for the first time in five months.

Sentiment has reversed since October, with options to buy European shares costing the most in more than four years relative to bearish puts, data compiled by Bloomberg show. Investors who had avoided peripheral markets such as Portugal, Italy, Greece and Spain are ready to resume buying on prospects Draghi will enact more stimulus, according to Lars Kreckel at Legal & General Investment Management.

“There’s clearly more optimism now,” said Kreckel, LGIM’s London-based global equity strategist. “As long as Draghi can keep the hope alive that the ECB is moving closer to doing sovereign QE, that’s enough for this week’s meeting. European equities have done quite well in the past few weeks but QE is still not yet fully priced into the market.”

Germany’s DAX Index in November led European equities to their best month since February. ECB Vice President Vitor Constancio echoed President Draghi last week, saying that the central bank will consider buying sovereign debt if existing stimulus proves insufficient. The majority of economists surveyed by Bloomberg News predict the ECB will eventually buy government bonds.

Draghi has also said that the ECB is committed to boosting prices as fast as possible. With euro-area inflation near zero, oil slumping and the economy struggling to grow, 21 percent of economists in November’s survey forecast the central bank will expand stimulus this month, while 69 percent predicted more support by the end of March.

As expectations of further ECB action pile up, so do the risks of disappointment, according to Teis Knuthsen, chief investment officer at Saxo Bank A/S’s private-banking unit in Hellerup, Denmark. Policy makers are in no rush to add to stimulus before current measures take effect, especially as opposition from Germany remains, he said.

“The purchase of government bonds is really what markets are waiting for, but it’s becoming too much of a consensus view,” Knuthsen said. “It’s clear that if the ECB does sovereign QE, it will only be in the spring of next year. There are still voices within the ECB that are against it, and it won’t be without problems from a legal perspective.”

Still, options traders are paying up for bullish wagers on European stocks. Three-month contracts betting on a 10 percent rally for the Euro Stoxx 50 Index cost the most on Nov. 24 relative to puts hedging against a 10 percent drop, according to data compiled by Bloomberg going back to 2010. The equities gauge added 0.2 percent to 3,243.74 at 8:22 a.m. in London.

Following four months of outflows where almost $4 billion was pulled from the Vanguard FTSE Europe ETF (VGK), investors have begun to put their money back. They poured about $194 million into the European equities ETF last month, the data show. Investor allocation toward the region rebounded from the lowest level in 15 months, according to Bank of America Corp.’s November fund-manager survey.

“Investors had disengaged from Europe,” said Graham Secker, a strategist at Morgan Stanley in London. “This is overdone. As ECB policy gains traction and the European macro news flow improves, this should allow for a rebound.”