Of all the harrowing things seen in the stock market Monday, one was a special nightmare for investors in what has become one of the stock market’s favorite strategies.
It’s short volatility, a bet against equity turbulence that traders have been piling into for years, lifting assets in related exchange-traded products to more than $3 billion, a record. Estimates of how much money is tied up in the tactic overall vary but one estimate from Chris Cole of the Artemis Capital Advisers hedge fund puts the total at more than $2 trillion.
That bet just got hit, hard. The Cboe Volatility Index jumped to 38.8 on Monday, its highest level since August 2015, prompting many betting against the measure to run for the exits and try to cover their trades.
In the scramble that followed, the S&P 500 index -- both a direct and indirect hedge for volatility trades--plunged. At least two VIX-related ETPs stopped trading for five minutes or more as volumes soared. And funds that went short continued to tumble in late trading with the VelocityShares Daily Inverse VIX Short-Term ETN down 84 percent from the close and the ProShares Short VIX Short-Term Futures ETF slumping 79 percent.
Those products “have effectively been wiped out," Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors, wrote in a note. Still, “the short vol products have covered 95 percent of their risk, meaning that the ‘VIX blowup’ event has effectively already happened. If the upward pressure on VIX (and to a lesser extent, downward pressure on S&P futures) was driven mostly by the VIX ETPs, that source of pressure is gone," he wrote.
Futures on the VIX slipped to as low as 25.3 in early Asian trading Tuesday, before paring that drop to 29.7 as of 11:06 a.m. in Hong Kong.
Reverse Course
The two largest exchange-traded products that wager on low volatility took in $1.7 billion in January, a record. And why not? Plowing cash into them has been a license to print money since roughly 2015. While the VIX’s average level since 1990 has been 19.3, during the past three years of market calm, that number has been close to 14.
To see how unexpected today’s events were, just look at options on the volatility gauge. The most-active VIX options on Monday were at strike prices like 15, 22, 18 and 16. VIX February calls with a 30 strike price weren’t even in the top 10 most-traded contracts.
Simultaneous Hedging