This Time They Got Their Selloff When They Bought VIX Notes
By Callie Bost
(Bloomberg) — While most U.S. investors were blindsided by
the biggest stock selloff in three weeks Friday, the same can?t
be said of owners of an exchange-traded note tied to volatility.
Speculators who have been piling into the iPath S&P 500 VIX
Short-Term Futures ETN in recent weeks had their bets pay off
when the Standard & Poor?s 500 Index slid 1.1 percent, causing
the security?s price to rebound from an all-time low. Shares
outstanding in the product known by its ticker VXX jumped to a
record two days earlier, data compiled by Bloomberg show.
Volatility soared in U.S. markets as a rout in global
equities Friday sent U.S. stocks to their first weekly loss of
the month amid disappointing earnings and signs of higher
inflation. The Chicago Board Options Exchange Volatility Index
saw its second 10 percent jump in five days.
?Across the board, there?s a sense of greater risk to the
market,? said Dan Deming, a managing director at Chicago-based
Equity Armor Investments. ?The market was searching for
direction. Earnings have been marginal at best and have been
ratcheted down. Some people were thinking it could be a good
place to scoop some VXX.?
Loading Up
The S&P 500 lost 1 percent last week. While a rally in
energy shares took the gauge to within 10 points of a record
Wednesday, it has now stalled short of a new high for 33
straight days, the longest streak since June 2013.
The Dow Jones Industrial Average tumbled the most in three
weeks Friday as shares of American Express Co. tumbled after
reporting earnings, data signaled stronger inflation and China
tightened trading rules.
?Friday took a lot of people by surprise,? Max Breier, a
senior equity derivatives trader at BMO Capital Markets Corp.,
said by phone. ?The expectation was that it would be a bit of a
yawner, and what we got instead was one of the larger down moves
we?ve seen in several weeks.?
Ways to speculate on how noisy the stock market will be
have exploded in the last decade with the advent of products
tied to the VIX. Strategies include relatively simple hedges
against equity losses, such as owning a security that aims to
mimic the gauge derived from S&P 500 options costs.
Creeping pessimism could be seen by comparing the
popularity of the iPath note with another security, the
VelocityShares Daily Inverse VIX Short-Term ETN, which usually
moves in the opposite direction and is known by its ticker
symbol XIV.
On April 15, there were more than 62,000 outstanding shares
in the VXX and about 12,000 in the XIV, data compiled by
Bloomberg show. The difference was the biggest divergence in
interest between the two in data going back back to 2010.
Rare Payout
The VIX soared 10 percent to 13.89 after hovering around
the lowest level in four months. Shares of VXX, which have lost
more than 99 percent of their value since inception, jumped as
much as 6.2 percent before paring gains.
?It?s a function of positioning and mentality that when
the market gets caught by surprise in this fashion, you get
larger moves in volatility,? Breier said.
Friday?s payout was a rare one for owners of the iPath
security. Shares outstanding in VXX climbed to multiple records
throughout 2013, a year when the S&P 500 gained 30 percent and
U.S. shares posted one of the broadest advances in history. A
high on July 23, 2014, came just before a 3.8 percent August
rally in the equities gauge.
Ironic Timing
While buyers of the VXX correctly predicted turmoil would
increase, other investors in volatility products weren?t
expecting turbulence. Hedge funds were short the most VIX
futures in nine months relative to long ones, according to
Commodity Futures Trading Commission data released Friday.
Large speculators in these contracts held about 186,000
short positions and 123,000 long ones through Tuesday, CFTC data
show.
Futures on the volatility gauge expiring in May ended
Friday at 15.68, 13 percent above the VIX?s closing price,
according to data compiled by Bloomberg. Contracts expiring in
June closed at 16.88, while July futures ended the day at 17.63.
?Market timing is very difficult to do,? Eric Metz, a
derivatives strategist and fund manager at RiverNorth Capital
Management LLC, said by phone. ?Buying VIX when it reaches a
floor, because it is mean-reverting, seems to be prudent. Yes,
the timing is ironic, but it?s happened before and it?ll happen
again.?