Surging credit volatility spurs option trading

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In the last few weeks, Europe's credit indexes - widely traded ways of betting on the creditworthiness of the continent's big companies - have registered some of their sharpest rises and falls since they began four years ago.

That has spurred demand for credit options - trades that hedge against further violent moves or, conversely, look to profit from them.

"We're seeing quite a bit of interest in trading options these days, and that's mainly because of the high volatility," said Soren Willemann, credit strategist at Barclays Capital.

"Credit options is still a fairly young market. In the past year or so, it has gained a lot of traction," he added.

The iTraxx Europe index, based on credit default swaps on 125 big investment-grade companies, has already risen five-fold since mid-2007, as the credit crunch has spread from risky U.S. mortgages to hobble some of the world's biggest banks.

That implies a five-fold rise in the cost of insuring its constituents' debt against default.

Willem Sels, credit strategist at Dresdner Kleinwort, said investors worried fresh bad news could trigger more widening in credit spreads, which would then feed on itself.

"What is driving volatility here is the expectation that something very dramatic would go wrong, and then there is a potential snowball effect," Sels said.

Some analysts forecast the Markit iTraxx Crossover index, currently at 560 basis points, could reach 600 basis points to 800 basis points in the next few months.

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