About That Short Volatility Trade...

While the S&P has rallied to record highs, VIX futures have essentially marched in place

by Bernie Schaeffer

Published on Oct 2, 2018 at 7:33 AM

The long-suffering iPath S&P 500 VIX Short-Term Futures ETN (VXX) continued on Friday to hang (admittedly by just a thread) above its Jan. 11 low of $25.84, despite the increasing pressure of its overhead 10-day moving average. Last week's relatively unremarkable VXX action capped off a calendar quarter in which the fund, which is designed to mirror the performance of short-term Cboe Volatility Index (VIX) futures, fell nearly 28%.

With the early February "volatility melt-up" that sent VIX to its highest levels since August 2015 so far in Wall Street's rearview as to be a distant memory, the large speculators whose activity is tracked in the weekly Commitments of Traders (CoT) reports have once again gotten quite comfortable in their net short position on VIX futures. This group, which we monitor closely for their remarkable ability to mistime major volatility moves, has spent the past four weeks lingering around their largest net short position of the year on VIX futures (after a "sobering up" period from February through early May during which these investors were in a somewhat rare net long position).

While the S&P 500 Index (SPX) rallied about 4% from the end of July into its Sept. 20 record closing high, VIX futures pretty much just marched in place. For what it's worth, this would also imply that the volatility selling trade has not been a lucrative one over this same period.

And this leads us to the question: "If it's approaching insanity to be selling volatility at current modest levels (when staring us in the face is a depiction of the disaster that most recently befell this trade in February 2018), how exactly can this trade possibly be described in circumstances under which a worthwhile positive return is not produced over a period of steady market rally to multiple new highs?"

The accompanying chart also depicts the palpable 2-point increase -- from the pre-February crisis period to the most recent months of the post-crisis period -- in the "floor" for the VIX futures (from 10 back then to 12 now). Perhaps this serves to lessen the chances for a rehashing of the February "accident," since volatility is now being sold at a level 2 points "less crazy" than it was in late 2017. But what does this increase in the futures' lower bound ultimately say about the prospective level of market volatility?

weekly vix futures chart

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, September 30.

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