Analysis: Traders hedge bets as budget talks turn to bluster

Wed Dec 19, 2012 5:28pm EST
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By Steven C. Johnson and Doris Frankel and Ryan Vlastelica

NEW YORK/CHICAGO (Reuters) - U.S. markets in the last few weeks have conveyed a strong sense of optimism over Washington's budget battle - perhaps a bit too much.

The benchmark S&P 500 index .SPX recently capped off its best two-day run in a month and the euro reached an 8-1/2-month peak against the dollar, largely on expectations that an agreement to avoid the "fiscal cliff" - $600 billion in automatic spending cuts and tax hikes set for early next year - is nearly at hand.

But at the risk of sounding like Ebenezer Scrooge, some investors fear a sudden run of bad news could snuff out the pre-holiday cheer and send stocks down. As a result, they are wading into the options market to hedge their bets and protect their profits.

"With all the uncertainty, we want exposure to sectors but we don't want to risk as much," said Michael Matousek, senior trader at U.S. Global Investors Inc, which manages about $3 billion. "We want to limit our positions because we don't know what will be impacted and by how much."

Republican Speaker of the House John Boehner, in a brief press conference on Wednesday, dared President Barack Obama to oppose Republican plans to cut taxes for all but those making $1 million or more in annual income.

After his remarks, both the S&P 500 .SPX and the Dow Jones industrials .DJI hit the day's lows.

Boehner's gambit, which followed another press conference where Obama suggested Republicans need to get over reflexive opposition of him, shows the two sides still have work to do to bridge their divide.

"It is very difficult to say if the optimism out there is warranted," said Alec Young, global equity strategist at S&P Equity Research in New York. "We don't know what's going on behind the scenes, and that makes it very difficult to account for all the uncertainty out there."   Continued...