VIX Bets at Record as Volatility Sinks to Five-Year Low
Investors are piling into securities that protect against losses in equities at the fastest rate ever after the Standard & Poor’s 500 Index climbed to the highest level in almost four years.
Demand to hedge gains pushed up the number of shares available for trading to records last week in four of the five largest exchange-traded funds and notes that track U.S. stock volatility, data compiled by Bloomberg show. For the iPath S&P 500 VIX Short-Term Futures ETN, the biggest of the securities, outstanding stock reached 100.1 million on March 16, up 51 percent since March 9 and more than fourfold since Dec. 30.
New shares of the iPath note were created to meet rising demand in each of the four days after the Federal Reserve raised its assessment of the U.S. economy on March 13 and the S&P 500 extended its best first-quarter rally since 1998. The securities track indexes linked to the Chicago Board Options Exchange Volatility Index, a gauge of fear known as the VIX that moves in the opposite direction of the S&P 500 on 85 percent of days.
“There’s an enormous amount of interest,” Scott Maidel, who helps oversee $141 billion as a senior money manager for equity derivatives at Russell Investments in Seattle, said in a March 16 phone interview. “These products are a convenient way to put on a short-term hedge or make a speculative bet if volatility should spike back up.”
ETNs are unsecured bank debt backed by their issuer’s credit, while exchange-traded funds hold assets such as stocks, bonds or futures contracts. With both, sponsors create and redeem shares based on the level of demand for the securities. That demand doesn’t affect the price since the funds and notes track the performance of an index.
Last Year’s Surge
The VIX fell 15 percent last week to 14.47, a level last seen in June 2007. The index, which measures the cost of S&P 500 options, dropped as low as 14.62 last year before jumping to 48 less than four months later in August. It has declined as the S&P 500 rose 28 percent since October, ending last week at an almost four-year high of 1,404.17.
The VIX has fallen five straight weeks, the longest streak since August 2008. The volatility gauge is down 38 percent this year and is 30 percent below its 22-year average of 20.55, data compiled by Bloomberg show. Europe’s VStoxx Index, which measures the cost of Euro Stoxx 50 Index options, slumped 19 percent to 18.52 last week, its lowest level since April 29. It increased 7.4 percent to 19.89 as of 10:17 a.m. in Frankfurt today.
Equities gained last week as the Fed upgraded its economic outlook and let banks such as JPMorgan Chase & Co. boost dividends after reviewing their financial strength. This year’s rally has been accompanied by smaller daily swings. The benchmark gauge for U.S. stocks has gained or lost an average 0.46 percent a day this year, compared with 1.04 percent in 2011, data compiled by Bloomberg show.
“Risk is back on and investors need to make sure they are fully allocated” to stocks, Tim Edwards, a vice president at Barclays Plc in New York, where he’s responsible for ETN product development, said on March 15 in a phone interview. “However, it’s risk plus a hedge. Investors are purchasing equities, but they are also buying some kind of protection because they believe volatility will return to the markets at some point.”
Credit Suisse Group AG on Feb. 21 suspended issuance in new shares of the VelocityShares Daily 2x VIX Short Term ETN (TVIX), or TVIX, another security that rises when equity swings widen. The Zurich-based bank took action after the note’s market value more than quadrupled this year to almost $700 million, according to data compiled by Bloomberg. Shares outstanding in TVIX, which aims to generate twice the daily return of an index tracking the VIX, had surged eightfold since Dec. 30.
Premium to Assets
The market capitalization for the note was $603.1 million on March 16, after it reached a record $695.6 million on March 6. The ETN is now trading at $14.81, a 36 percent premium over its net asset value.
For Barclays’s VXX, the increase in outstanding notes has brought the market value of the ETN to $2.16 billion, the highest level since October 2010.
Shares outstanding of the ProShares Ultra VIX Short-Term Futures ETF, which like TVIX seeks to offer double the daily return of an index tracking the volatility gauge, rose more than 13-fold since Feb. 21 to a record 8.34 million on March 16. The market capitalization of the so-called UVXY has risen to $206.6 million, the highest ever and 60 times more than when the fund started in October.
“With no new TVIX shares being created, UVXY is the only other exchange-traded product for investors who want levered exposure to a sudden spike in short-term volatility,” Boris Lerner, a New York-based equity derivatives strategist at Morgan Stanley, wrote in an e-mail on March 15.
Shares outstanding for the iPath S&P 500 Dynamic VIX ETN rose to a record 3.5 million on March 16, bringing its market value to $204.3 million. There were 2.7 million shares of the ProShares VIX Short-Term Futures ETF, the most ever, data compiled by Bloomberg show. That fund had a market capitalization of $123.6 million as of March 16.
Six-month futures on the VIX closed at 27.40 on March 16, a record high versus the volatility gauge, while all VIX futures expiring in April or later closed at or above 21.60. The index hasn’t closed above that level since January.
Some options traders are taking advantage of the spread between the VIX and its futures contracts as they prepare for an extended period of low equity market volatility. Ownership of VIX puts increased 62 percent to a record 2.87 million on March 15 from the last options expiration on Feb. 17, while call open interest gained 47 percent 3.88 million, data compiled by Bloomberg show.
Investors are buying out-of-the money puts that will pay if the VIX remains where it is or declines, according to Bouhari Arouna of BNP Paribas SA. That’s a sign they are becoming more confident about the economy, he said.
“The VIX option flow has dramatically changed recently,” Arouna, an equity derivatives strategist at BNP Paribas in New York, said in a telephone interview on March 14. “Investors are betting on the VIX futures curve to either shift down based on the improved economic outlook or for the term structure to stay where it is.”
Confidence among U.S. consumers unexpectedly dropped in March to the lowest level this year, the Thomson Reuters/University of Michigan preliminary index of sentiment showed on March 16.
When the VIX surged 50 percent on Aug. 8 after S&P stripped the U.S. of its AAA credit rating, the VXX (VXX) gained 15 percent in a single day. Now, investors want to ensure they’re protected from another increase in volatility, MKM Partners LLC’s Jim Strugger said.
“After the volatility spike last August, investors who did not have long volatility exposure in place were saying, ‘I knew this was going to happen,’” Strugger, an MKM Partners derivatives strategist in Stamford, Connecticut, said in a telephone interview last week. “The common refrain now seems to be, ‘I’m not going to miss this one.’”
To contact the reporters on this story: Nikolaj Gammeltoft in New York at firstname.lastname@example.org; Cecile Vannucci in Amsterdam at email@example.com; Matt Robinson in New York at firstname.lastname@example.org
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