One of the hottest strategies of the bull market for stocks may be getting too popular for its own good, placing billions of dollars and a slew of money managers at risk of being burned.

The short-volatility trade, where investors sell options to bet against equity price swings, is becoming less profitable. The strategy has in theory made no money for investors 42% of the time since 2018, according to new research, compared with a recent average of about 30%.

The findings represent a new and potentially more insidious threat to a trade that famously weathered several post-crisis blow ups only to emerge stronger. At stake are billions in funds with names such as “buy-write,” “put-write” and “iron-condor,” not to mention the now notorious exchange-traded products hammered in last year’s “volmageddon” episode.

Options-selling strategies like this “nicely outperformed” the S&P 500 from 1990 to 2009, the analysis from money manager IPS Strategic Capital said. But returns since the financial crisis have petered out.

“Professional money managers and traders must ask the question, is the risk/return profile favorable and is it time to look at the other side of the trade?” authors Dominick Paoloni and Patrick Hennessy wrote.

Tipping Point

Since 2009, a suite of indexes tracking options-selling strategies from CBOE have underperformed the S&P 500 Index by as much as 300 percentage points on a total return basis, data show.

Paoloni and Hennessy argue the lag is attributable to the deteriorating spread between implied and realized equity index volatility, which is known as the volatility risk premium.

It’s the engine behind the short-vol trade: The tendency for the market to price in a higher cushion for price swings compared with what comes to pass -- giving traders an opportunity to sell options and earn a premium along the way.

“We still think there is a volatility risk premium,” said Benn Eifert, CIO of QVR Advisors. “But it’s a third of what it used to be.”

First « 1 2 3 » Next