Traders who made record bets on securities that track U.S. stock volatility scored the biggest gains in almost two months yesterday as equities plunged.
The iPath S&P 500 VIX Short-Term Futures exchange-traded note climbed 12 percent to $20.52 and the ProShares Ultra VIX Short-Term Futures ETF (UVXY) soared 23 percent to $7.75, according to data compiled by Bloomberg. Both increases were the biggest since Feb. 25. The rallies came as the Standard & Poor’s 500 Index slumped 2.3 percent to 1,552.36 and the Chicago Board Options Exchange Volatility Index (VIX) increased 43 percent.
Traders have been piling into the notes to speculate on losses in equities and protect profits after almost $2 trillion was added to the value of American shares this year. Gains have been hard to come by. The iPath note tied to the volatility gauge known as the VIX fell for five straight days before yesterday and the ProShares fund lost almost 70 percent in 2013, data compiled by Bloomberg show.
“Today is the reason why you hold VIX,” Mark Mandell, who owns the iPath note as a fund manager for U.S. equity long-short strategies at Dalton Investments, said in a phone interview. The Santa Monica, California-based firm oversees over $2 billion. “There are macro concerns which have given us reason to own a position in long volatility.”
The S&P 500 plunged yesterday after China’s economy expanded at a slower rate than forecast and gold declined the most since 1980. Losses were led by energy and commodity companies, which retreated 3.9 percent. The VIX advance was the biggest since August 2011.
The iPath note fell 7.9 percent to $18.90 today, while ProShares security slipped 18 percent to $6.39 as the benchmark U.S volatility gauge retreated 19 percent to 13.96.
Outstanding shares of the volatility securities more than doubled in 2013, reaching the highest levels ever, according to data compiled by Bloomberg. Since 2010, the S&P 500 has dropped an average 5.2 percent in the second quarter.
The VIX, which moves in the opposite direction of the S&P 500 (SPXL1) about 80 percent of the time, has declined as share prices surged after the Federal Reserve’s unprecedented bond purchases and three straight years of profit growth. The S&P 500 rallied 8.9 percent this year and has more than doubled from its 12-year low in March 2009.
“In our 2013 outlook, we saw equities rallying to 2007 highs into about mid-year,” Peter Cecchini, global head of institutional equity derivatives at New York-based Cantor Fitzgerald LP, said in an interview. “Because we’ve run so far so fast, we expect volatility may re-emerge a bit sooner.”
The S&P 500 rallied 12 percent in the first quarter of last year and slipped 3.3 percent in the second. The previous year, the index gained 5.4 percent in the first three months and lost 0.4 percent in the second quarter. The 12 percent slump in the S&P 500 (SPX) between April 2010 and June 2010 followed a 4.9 percent increase in the first quarter.
Equity hedge funds have trailed returns in U.S. stocks amid skepticism about the rally’s sustainability. The HFRX Equity Hedge Index of hedge-fund performance rose 5 percent this year, less than the gain for the S&P 500, according to Hedge Fund Research Inc.
A gauge of hedge-fund bullishness, which measures how much they’re betting on rising shares, rose to 51.6 last week from 50.8 on April 3, according to a survey by Washington-based ISI. The high was 62 in May 2007. The ratio of bullish to bearish bets rose above 50 in January for the first time since July 2011. A reading above 50 suggests a bias toward long bets relative to normal positioning.
The S&P 500 will climb to new highs as individual investors add money back to mutual funds, according to Randall Warren of Warren Financial Service in Exton, Pennsylvania. While about $18.4 billion was sent to U.S. stock mutual funds in January, the deposits shrunk to $1.1 billion for February and March, according to the Investment Company Institute.
“Investors should be in this market,” Warren, who oversees about $80 million including options as chief investment officer of Warren Financial Service, said April 12 by phone. “The market is showing incredible resilience and it will likely keep going up.”
Strategists from Goldman Sachs Group Inc. to Morgan Stanley and Deutsche Bank AG have increased their S&P 500 forecasts for the year. Garry Evans of HSBC Holdings Plc raised his estimate on April 9, predicting the index may rise to 1,680 by the end of 2013.
Individual investors are less optimistic. Expectations that stock prices will fall over the next six months increased 26 percentage points to 54.5 percent last week, the highest level of bearishness since July 2010, according to a survey released last week from the American Association of Individual Investors.
Payrolls grew by 88,000 in March, the smallest gain in nine months and less than the most-pessimistic forecast in a Bloomberg survey, Labor Department data showed April 5. Retail sales fell 0.4 percent last month, according to the Commerce Department, and the Thomson Reuters/University of Michigan preliminary index of consumer sentiment declined to 72.3 in April from 78.6 a month earlier.
Wagers that U.S. stock volatility will rebound have reached a three-year high. The number of VIX calls outstanding rose to 7.31 million on April 9, more than three times the number of puts, according to data compiled by Bloomberg. That’s the highest ratio of calls-to-puts since February 2010.
All five most-owned VIX contracts were calls. April 20 calls, with an exercise level 16 percent above the last close, and April 18 calls has the largest open interest.
“Hedging is cheap,” Brian Bier, head of equity derivatives sales and trading at Macro Risk Advisors LLC, said in an April 12 telephone interview in New York. “More people are taking advantage of the cheap volatility to express directional views to the upside in the VIX.”