Markets Reverse Losses After Attack, But Keep Watchful Eye For News

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The Boston Marathon bomb attacks had a fleeting impact on markets, but that could change, depending on what investigators uncover.

For that reason, traders are hyper-focused on news about the explosions near the finish line of the marathon Monday, which killed three and injured dozens. So far, there are no suspects in custody.

The initial reaction to the attacks Monday sent traders into quick defensive positions. It prompted heavy near-term put buying on stocks and drove buyers into of bonds. Some of those trades have unwound, with stocks higher Tuesday and bond yields lower. After a big spike Monday, the CBOE 's Volatility Index, or VIX slid about 15 percent as market fear faded.

"It depends on what it is...If it's just one disgruntled soul then you pray for the people who were affected, but know life will go on," said Ward McCarthy, chief financial economist at Jefferies. "If there's some kind of cell here or something, and this is planned to be the first of a series of things then it's going to add to market anxieties."

The Dow saw triple digit gains Tuesday, and bond yields were back to pre-attack levels, with the 10-year yield at 1.71 percent. The bomb attacks, just before 3 p.m. ET Monday, drove an already weak stock market to its lows of the day and sent the 10-year note yield to 1.68 percent, its lowest close of the year.

The Dow finished Monday 265 points lower at 14,559, a decline of 1.8 percent, and the S&P 500 sank 2.3 percent to 1552

"If you look at where the Dow closed, I think at least 40 percent of that decline was related to that and we recovered it at the open," said Randy Frederick, managing director of active trading and derivatives at Charles Schwab. Frederick said if a suspect is caught, the market could rally, but if there is another event, the market will sell off again.

"People are talking about it...what you've really seen since yesterday is people taking profits (in Treasurys). Stocks are coming back. One thing about the market in recent years, they have become increasingly resilient," said McCarthy. In the final hour of trading Monday, investors rushed the S&P 500 options pit.

As a result, the VIX spiked on record volume of 449,955 contracts, ending the day 43 percent higher at 17.27. It had been up 25 percent earlier in the day as a sell-off in gold and other commodities spooked stocks and forced margin selling across markets.

"This was completely out of left field. You can't prepare for these things," said Frederick. "Even if you're out there buying volatility related would have had to get into them and sold them right at the end of the day because they are already down today." The VIX is a measure of market expectations of near term volatility, based on the range of S&P 500 index options.

The S&P options pit at the Chicago Board of Options Exchange was bustling Monday afternoon. "Guys came in and started buying May and April out-of-the-money puts. We saw a lot of customers right when the initial news was coming out. People were coming in and buying puts purely for a directional trade," said Patrick Kernan of Cardinal Capital. "It wasn't just like one customer was doing it. It was across the board. We think it was a knee-jerk reaction to the bombings."

"The volatility was going up in gaps, which equates to a lot of uncertainty," he said. Kernan said if there are no other events, the markets should calm down. He said while most investors were reaching for short term protection, one major investor was buying June calls on the S&P 500 in the last hour of trading Monday.

"I think a way to characterize today is 'turnaround Tuesday,'" said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "I think it is mostly short covering rather than new buying coming in, like in the stock market and gold market."

Volatility remained elevated but not nearly at Monday's levels. Earlier Tuesday, Larry McDonald, senior director at Newedge said, for instance that the cost of the 153 April 20 options on the SPDR S&P 500 ETF SPY were trading well below Monday's level but were still about three times the amount they cost last week.

"The April 20 SPY is 30 handles out of the money. and those are trading at 28, 29 cents but yesterday they traded up to 78 cents," he said. "We could have bought those all day on Friday at 8 cents. That's massive." Buyers of those options are betting the SPY will trade below 153 by the end of the week.

Some quick hedging was taking place in ETFs, inlcuding the SPDR S&P Home Builder ETF XBH home builders, which traders sold Monday afternoon.