How Hedge Funds Are Playing The VIX

Should you follow suit with hedge funds when it comes to VIX -- or fade the big-money players?

by Adam Warner

Published on May 13, 2015 at 9:01 AM

As long as we're looking for contra tells in VIX-land, here's an interesting one. This, via Bloomberg:

"After the storm, calm. That's what happened to U.S. equities in 2014 and, going by bets in volatility futures, that's what big speculators see occurring again. Short positions in futures tied to the Chicago Board Options Exchange Volatility Index have tripled since February and now outnumber long ones by the most in 11 months, Commodity Futures Trading Commission data released Friday show.

"...Hedge funds and other large speculators in VIX futures held about 138,000 long positions and 213,000 short ones through May 5, CFTC data show. The bets on a lower VIX have climbed steadily since February as the gauge of S&P 500 options costs has dropped 34 percent."

Now of course, it's hard to blame them. Here's the CBOE Volatility Index (VIX) futures on Tuesday after our weekly bout of market ugliness:

Warner11

 Realized volatility tends to hover near 10. VIX itself has spent most of 2015 in the 13-16 range, yet you can sell VIX futures half a year out in the 18-19 range. Always. Same as it ever was.

The thought is that the Fed will keep delaying rate hikes, and that's not a crazy thought, of course. But to me, it's more just about the reality of volatile markets and the permanent bid-up for time. If you're willing to become the insurance company against that lasting VIX pop, that will surely happen someday; you always have the wind at your back. You're going to take a hit someday, but it's likely you will have done so well until then that you can afford an occasional accident.

From that standpoint, it makes perfect sense that large hedgies are playing that game in a big way. In and of itself, it's not a contra tell to see smart money making a sensible play.

The thing is, this opportunity has existed forever -- or at least forever in VIX-time. Ever since volatility declined from the 2008 spike, the markets have priced in a future VIX "mean" reversion. They could have slapped this trade on over and over again. So, the fact that they're playing it larger now does have some significance. I'm definitely a believer that "zigging" when the masses "zag" is a sensible strategy. So, by that thinking, I should buy vol into this.

On the flip side, though, these aren't "masses" -- these are hedgies. Fading them is more of a mixed bag. And again, it's a strategy on their part that makes some sense given the pricing structure. So, I'm going to file this away as an interesting data point, but not something I'm going to react much to.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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