Investors have ratcheted up bets that the US stock market’s recent turbulence will ease despite the biggest monthly losses in almost a year, doubling the size of two popular exchange traded funds this month.
There has been a proliferation of exchange-traded products that are tied to the value of the Vix, Wall Street’s so-called “Fear Gauge”. The Vix reflects the turbulence of the S&P 500 implied by option prices, and is seen as a measure of investor nervousness.
One of the most notable phenomena in global financial markets this year has been the evaporation of volatility, which has netted investors who bet on tranquility some big gains. But the popularity of these low-volatility bets is worrying some fund managers and analysts, given how quickly investors can be wiped out if volatility increases.
“Selling Vix is very crowded and fraught with danger,” said Peter Tchir, an analyst at Brean Capital. He fears that the unusual nature of short-volatility trades could cause wider dislocations in financial markets should they unravel.
“I think that the strategy of selling short-term Vix futures is not only extremely popular, but that the recent spike in Vix encouraged a large number of investors …to reload on the trade or enter into it for the first time,” he said in a note to clients this month.
Despite a bout of turbulence this month the willingness to bet on the stock market calming down continues to increase, with two “inverse” Vix ETPs — which gain when the Vix index falls — more than doubling in size since early August.
The assets held by the two ETPs, known by their tickers XIV and SVXY, have climbed in value from $1.2bn on August 10 to a record $2.6bn last week, and currently stand at $2.5bn. That comes despite the renewed turbulence resulting in the share prices of the XIV and SVXY losing about 13-14 per cent in August, their first monthly declines in almost a year.
Investors are willing to keep betting on turbulence abating because doing so has been hugely profitable in the post-crisis era. Shares in the XIV have risen 218 per cent since the start of 2016, even after this month’s painful drop.
“They sell the spike [but it] seems to be gaining popularity,” Mr Tchir told the FT. “People really want to sell volatility because they think that’s what works.”
The growth comes alongside broader record trading this month in futures and options tied to the Vix, according to CBOE data. But some analysts have argued that the Vix has remained muted because actual, realised volatility in US stocks has been low and the economic fundamentals remain steady.
“Low equity volatility has been a major concern for months …We think volatility should be lower and risk-taking higher given the environment of low fundamental volatility,” Morgan Stanley analysts said in a note last week.
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