April 14, 2017 / 3:31 AM / a year ago

Nikkei licks wounds near 4-month low, spooked by North Korea worries

* Rising tension over North Korea keeps investors sidelined

* Bank shares hit by falling bond yields

* Investors hedge against tail risk by buying put options

By Hideyuki Sano

TOKYO, April 14 (Reuters) - Japanese shares licked their wounds near four-month lows on Friday as rising tensions in the Korean peninsular and other parts of the world threatened investors’ bullish expectations on the global and the Japanese economy.

“There’s been nothing to cheer about over the last 24 hours. Geopolitical tensions seem to be rising all over the place,” said Masahiro Ayukai, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities.

Nikkei dropped 0.3 percent in morning trade to 18,364.68, hovering just above Thursday’s four-month low and having fallen more than 6 percent in the past month.

Although their retreat has brought down the Nikkei’s valuation to reasonable levels — just above 15 times its earnings — rising geopolitical uncertainties are raising doubts about whether such estimates are reasonable.

Investors fear North Korea may conduct a nuclear test or other actions that could provoke neighbouring countries as early as Saturday, when the reclusive state celebrates the birthday of the country’s founding president.

The Pentagon on Thursday declined to comment on an NBC report that the United States is prepared to launch a pre-emptive conventional weapons strike should officials be convinced North Korea was about to follow through with a nuclear weapons test.

News that the United States dropped “the mother of all bombs”, the largest non-nuclear device it has ever unleashed in combat, in Afghanistan on Thursday only soured investor mood further.

The broader Topix dropped 0.5 percent, touching its lowest level in almost five months. It has fallen 3.4 percent so far this month, led by falls in large-cap financial shares, which have been hurt by falling bond yields globally.

Investors were selling shares that they once believed would benefit from U.S. President Donald Trump’s stimulus and deregulation policies, as they grew disenchanted with the prospects that he could push them through the Congress quickly.

Investors are also trying to protect against sudden fall in stock prices by buying put options, the price of which rises when the price of underlying assets falls.

The implied volatility of the Nikkei hit a five-month high of 24.3 percent on Thursday and last stood at 22 percent.

The volatility gap between the Nikkei’s puts and calls has widened to its highest level since June last year to 8.8 percentage point on Thursday, said Michiro Naito, executive director of equity derivative strategies at JPMorgan.

It eased back on Friday but still remained elevated at 7.4 percent, compared to around 4 percent just three weeks ago, he said, suggesting investors are very much concerned about downside risks.

“There’s been an amazing rush to hedge against tail risks,” Naito said. (Editing by Sam Holmes)

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