Photographer: John Taggart/Bloomberg

Volatility Trade Flames Out as VIX-Loving Bears Cash In on Notes

  • ETFs tracking VIX see demand fall most since December 2015
  • After waiting out calm, fund managers finally see profits

After months of waiting for the volatility trade to pay off, U.S. equity bears are finally cashing in.

Individuals took a break from loading up on protective positions and sold exchange-traded notes and funds that track the CBOE Volatility Index at the fastest pace since the start of the year. It came as stocks were jolted from a slumber that persisted for almost two months, giving volatility-obsessed bears a rare payday. The S&P 500 Index wavered again Monday, closing little changed at 2,139.12 at 4 p.m. in New York, after wiping out a 0.7 percent rally.

Take the iPath S&P 500 VIX Short-Term Futures ETN, the biggest security tracking the stock market’s fear gauge. Owning the VXX amounts to speculation that swings will grow more frenetic in U.S. equities, and outstanding shares increased nearly 11-fold this year. In the five days through Friday, outstanding shares fell 16 percent for the biggest drop since December, data compiled by Bloomberg show.

“There have been very large inflows into the VXX in 2016, and being long VXX this year has been a very unprofitable trade,” said Pravit Chintawongvanich, head derivatives strategist at the New York-based Macro Risk Advisors. “So on any vol spike, people are trying to sell out.”

Through last week, flows into the VXX had piled up to $2 billion, putting the security on pace for its biggest year since 2012. After the VIX climbed 40 percent in one day for its biggest daily advance since the Brexit vote, investors sold out of their VXX holdings at the fastest rate in a year.

On futures exchanges, venues dominated by hedge funds, bulls have been taking the opposite bet, going all-in on the end of market turbulence. Their conviction showed signs of wavering last week as net short positions fell by nearly 16 percent. On the other side of the trade, long VIX, almost 50,000 contracts were sold, the biggest weekly contraction since June, according to data compiled by Macro Risk Advisors.

The S&P 500 Index failed to hold gains Monday, with a rebound in banks offset by declines of at least 1.1 percent in Apple Inc., Verizon Communications Inc. and Intel Corp. Lenders trimmed gains by half as U.S. Treasuries swung between gains and losses. The Dow Jones Industrial Average lost 3.63 points to 18,120.07, erasing a climb of as much as 131 points. The Nasdaq 100 Index dropped 0.5 percent. About 6.1 billion shares traded hands on U.S. exchanges, 10 percent below the three-month average.

“There’s a chance for volatility to remain, simply because I don’t think the Fed is going to clear up any uncertainty about the path of interest rates,” said Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird, which oversees $110 billion. “The Fed will not raise interest rates this week, but they will be pretty aggressive in saying a rate increase is coming.”

Volatility has flared as central banks signaled they are rethinking the approach to the monetary stimulus. The S&P 500 wobbled Monday, after rising 0.5 percent in the five days through Friday to bounce from its worst week since February. The benchmark trades at about 18.2 times estimated earnings, the highest since 2009, and for stocks to hit forecasts for next year, they would have to increase profits by 13 percent, something that hasn’t happened since 2011.

A report on August housing starts tomorrow is the last bit of significant data to offer an indication on the strength of U.S. growth before the Federal Reserve announces its interest-rate decision on Wednesday. A measure today showed confidence among homebuilders rose to an 11-month high in September.

Reports last week offered contrasting evidence of the state of the economy: the cost of living rose more in August than projected, while consumer confidence this month held at the lowest level since April. A gauge tracking the degree to which data miss or exceed economists’ estimates is near a two-month low.

The odds for a September rate increase have fallen to 20 percent from 30 percent less than two weeks ago, with December the first month with more than even odds of a hike. Economists surveyed by Bloomberg expect the Fed to keep rates unchanged, while strengthening guidance about its intentions to raise borrowing costs soon. The Bank of Japan will also undertake a review of its monetary policy this week.

In Monday’s trading, an index of homebuilders climbed 1.2 percent after the stronger confidence reading. Lennar Corp. and PulteGroup Inc. rose more than 1.5 percent.

General Motors Co. rallied 2.4 percent, the most in two months, after Morgan Stanley upgraded the stock to the equivalent of buy from neutral. Utilities advanced for a fourth day, the longest streak since June 30. Merck & Co. lost 1.5 percent, slipping to a six-week low to weigh on the health-care group.

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