How Unusual is the Current Volatility Lull?

Increasing appetites for VIX derivatives may be bullish for stocks … or not

by Adam Warner

    Published on Mar 4, 2015 at 8:23 AM
    Updated on Apr 20, 2015 at 5:10 PM

    When the going gets tough for volatility, the tough get going … right back into CBOE Volatility Index (VIX) derivatives! This, from Bloomberg:

    "Traders in one of the most popular exchange-traded notes tracking volatility are convinced the calm in U.S. stocks won't last.

    Investors added $514 million in February to the iPath S&P 500 VIX Short-Term Futures ETN, known by its ticker symbol VXX, for its biggest monthly inflows since July 2013."

    That number (I believe) refers to shares created. And the contrarian in me says that's bullish for stocks. When investors/traders buck a trend with their feet, they often regret it. But perhaps that's not the case here:

    "Shares outstanding in VXX, the VelocityShares Daily 2x VIX Short Term ETN and the ProShares Ultra VIX Short-Term Futures exchange-traded fund increased 72 percent last month to 263 million on Feb. 27, a record for positions in all three products. Historically, a rise in traders' interest in these funds has preceded spikes in equity volatility, according to Jason Goepfert at Sundial Capital Research Inc.

    'When shares outstanding rise quickly, it has coincided with declining volatility and a VIX that was about to rise in the months ahead,' Goepfert, president at Sundial in Blaine, Minnesota, wrote in a Feb. 27 note. 'Based on the recent jump in the shares outstanding, this should be a negative for stocks.'"

    There's only one example cited, the volatility lift from last December. But Jason's work is terrific, so I wouldn't in any way discount his conclusion. For what it's worth, VIX futures set volume records in February, as well. But, I'm just not convinced in any way that volatility traders net-net represent any form of "smart" money.

    VIX futures sit in contango now, just like always. Ten-day realized volatility now is near 4, VIX itself is near 14, and VIX futures out to October are near 19. The options market itself expects realized volatility to pick up. And the futures market expects implied volatility to pick up. Or, perhaps more accurately, is willing to a pay a premium on top of VIX itself to hedge, in some fashion, eight months out in time.

    And again, this isn't unusual -- this is how the volatility picture almost always looks, save for the fact that backwards-looking realized volatility is on somewhat of a low ebb. So will those volatility buyers and portfolio hedgers prove correct? Perhaps -- but they're usually not. And save for some extra volume, I just don't see how the big picture looks much different from any other time of sluggish volatility.

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


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