Investors started pulling money out of the leveraged volatility fund just as VIX ramped higher in October
The following is a reprint of the market commentary from the November 2018 edition of The Option Advisor, published on October 26. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.
The ProShares Ultra VIX Short-Term Futures ETF (UVXY) was one of many volatility derivatives to get an overhaul after the Cboe Volatility Index (VIX) "explosion" that rattled markets in the early innings of 2018. Now, rather than tracking double the daily return of short-term VIX futures (a weighted mix of first- and second-month futures with an average maturity of one month until expiration), UVXY aims to return 1.5 times the projected volatility in stocks over the next month.
That adjustment to the UVXY methodology likely doesn't account for the apparent sea change in fund flows that serves as our point of focus this month, but it's useful context nonetheless for our analysis of this suddenly outperforming exchange-traded fund (ETF), which has received a shot in the arm this month as the stock market has spiraled into panic mode.
In fact, let's back up even farther. Since the start of 2015 to present, UVXY has registered net inflows of $3.74 billion, even as its net asset value (NAV) has cratered by some 84.1% over the past three years (per etf.com). Assets under management (AUM) currently stands at $302 million -- yes, with an "m" -- as those inflow dollars have been mostly eviscerated.
UVXY investors seemed generally undeterred from "business as usual" through the first nine of months of 2018, as net inflows totaled $207.39 million through the first three calendar quarters of the year. But simultaneous with the start of October, flows began to reverse out of UVXY -- just as the leveraged volatility tracker was beginning to shoot higher, and as the stock market was sinking.
These outflows began in earnest on Oct. 5, when $90.58 million was liquidated, and so far seem to have peaked on Oct. 11, when $104.46 million was yanked out of UVXY -- the same session the ETF peaked at $62.88, which was (at the time) a three-month high share price. As of this writing, some $333.61 million in outflows have been logged for UVXY on a month-to-date basis, bringing the current 2018 balance to $126.21 million in net outflows year-to-date.
The heavy liquidations in UVXY month-to-date have been accompanied by significant put accumulations, as well. In the past 10 trading days, the biggest open interest increases on UVXY have taken place at the now deep-out-of-the-money weekly 10/26 40-strike put (+5,504 contracts), the November 50 put (+4,992 contracts), and the December 50 put (+4,900 contracts). Data from the major options exchanges confirms a recent skew toward buy-to-open volume at all three strikes in recent weeks, suggesting speculative players are betting on UVXY to drop sharply from its recent heights.
So have UVXY players -- after incinerating multi-billions of dollars in recent years chasing an ETF that whacked them for 90% (or more) of their stake -- now turned "savvy"? Or might they now be getting a case of cold feet just ahead of that very big UVXY rally that they'd previously chased in vain?
Per the accompanying daily chart of UVXY, traders who may have hoped to "sell high" on that Oct. 11 pop have already proven to be premature, as the fund went on to tag a new closing high of $63.98 as recently as Oct. 24, in the process settling above its 200-day moving average (in red). The close above this benchmark trendline marked what is so far the culmination of sorts of UVXY's relatively slow, patient march higher off its Oct. 3 year-to-date closing low, during which the shares took out resistance at a number of key moving averages, as shown.
The wild October ride in the stock market shows no signs of slowing just yet, and there's plenty of "uncertainty overhang" yet to play out -- in the form of midterm elections, Fed policy, China trade, and a couple more weeks of earnings -- before investors might have a chance for some respite. And if we can agree that the dogged inflows into UVXY in 2015 through 2017 were most certainly a "wrong-way" indicator with regards to the price action, then a fair hypothesis here seems to be that the massive UVXY outflows so far in October -- occurring against a backdrop of robust gains in the underlying -- should be viewed as a warning sign that there may yet be another leg or two left to the volatility ramp.
