VIX Contracts at Record as Traders Lock in Stock Gains

Capstone Holding Group LLC CEO Paul Britton
“It’s a newer strategy, people aren’t as familiar with it,” Paul Britton, chief executive officer of New York-based Capstone Investment Advisors LLC, which manages about $1.7 billion and focuses on volatility trading, said in a phone interview. Photographer: Jin Lee/Bloomberg

Investors are boosting options and futures wagers based on U.S. equity-market volatility to a record to protect gains after the Standard & Poor’s 500 Index jumped to an almost five-year high.

The number of futures on the Chicago Board Options Exchange Volatility Index, or VIX, has more than tripled to 411,407 this year, according to data compiled by Bloomberg. Outstanding options on the gauge, which tracks the cost of insuring against S&P 500 losses, has more than doubled to 7.48 million in 2012. The level is close to the peak reached last month.

Investors are turning to securities based on volatility to hedge against losses after the S&P 500 surged 16 percent this year, putting it on track for the biggest annual gain since 2009. Funds that bet on market swings attracted almost as much cash in the first six months of this year as in all of 2011, data from Hedge Fund Research Inc. show.

“Volatility has become more attractive now as an asset class,” Nikolaos Panigirtzoglou, JPMorgan Chase & Co.’s European head of global asset allocation said in a Sept. 12 phone interview from London. JPMorgan has $2.3 trillion in total assets. “When you have a crisis, volatility spikes. So buying volatility provides a generic crisis hedge. VIX futures and options open interest has increased sharply as hedge funds have become more heavy users.”

Volatility Trading

Investors are using options to buffer against losses in other assets. In the strategy, known as volatility trading, fund managers buy the contracts to improve the odds that the value of their fund will be preserved during a market rout. When the S&P 500 plunged 38 percent in 2008, the VIX soared 78 percent.

About $874 million was added to volatility funds in the first half of the year, according to data compiled by Chicago-based HFR. That compares with inflows of $914 million for all of last year and withdrawals in 2010 and 2009. Investors poured $1.35 billion into the investments in 2007, the highest since the start of the data in 1990.

“It’s what I call a bull market in fear,” Christopher Cole, founder of volatility investment-management firm Artemis Capital Management LLC in Santa Monica, California, said in a phone interview. “There’s a tremendous amount of shock risk between deflationary events and the unintended consequences of the actions of global central banks and policy makers. As long as these issues remain unresolved, investors will continue to bid up volatility.”

Fed Stimulus

The U.S. Federal Reserve said yesterday it would buy mortgage-backed securities, adding to the $2.3 trillion of stimulus that the central bank committed to spur growth in the world’s largest economy.

The HFRX RV Volatility Index, which tracks 40 funds that bet on stock swings, climbed 4.8 percent this year through the end of July. The broader HFRX Global Hedge Fund is up 2.7 percent in 2012. Volatility is a small part of the fund industry, with inflows this year accounting for 4.3 percent of the $20.4 billion added to hedge funds during the first half of this year, HFR data show.

“It’s a newer strategy, people aren’t as familiar with it,” Paul Britton, chief executive officer of New York-based Capstone Investment Advisors LLC, which manages about $1.7 billion and focuses on volatility trading, said in a phone interview. “If we can educate people on the matter, then we have a chance to make them comfortable with the asset class, and where it would fit in with their overall portfolio.”

Volume Drop

U.S. options trading is poised for the biggest annual drop since 1988. The number of contracts changing hands fell 13 percent to 2.70 billion during the first eight months of 2012, according to data compiled by Chicago-based Options Clearing Corp. Should the pace continue, that would mark the second-biggest drop since OCC data began in 1973.

The VIX slid 11 percent to 14.05 yesterday, the lowest level since Aug. 20. That’s 31 percent below its historical average of 20.50 since 1990. It rose 3.3 percent to 14.51 today. The European counterpart, the VStoxx Index, a measure of Euro Stoxx 50 Index option prices, lost 10 percent to 21.11.

The number of shares outstanding for exchange-traded funds that profit from volatility gains in U.S. stocks has also increased. Shares of the Barclays Plc’s iPath S&P 500 VIX Short-Term Futures ETN, the biggest of the securities, jumped almost nine-fold this year and touched a record 192 million on Sept. 7, data compiled by Bloomberg show.

“People are fundamentally worried about uncertainty,” Kathryn Kaminski, chief investment officer at Alpha K Capital, a fund of hedge funds, said in a phone interview. “More pension funds are starting to wake up to the tune of either selling vol or getting involved in vol, which means that this space has a lot more growth potential for the next few years.”

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