Volatility Bets Rise to Record as VIX at Five-Year Low
Investors are piling into securities that gain should equity volatility increase, a bearish bet on stocks that was last popular when the Standard & Poor’s 500 Index climbed above 1,400 in March.
Outstanding shares jumped to a record for the three most- used exchange-traded securities that profit from volatility gains in U.S. stocks, according to data compiled by Bloomberg. The Chicago Board Options Exchange Volatility Index, known as the VIX, dropped 2.8 percent to 14.44 as of 9:57 a.m. in New York after reaching its lowest level since June 2007 earlier this week.
Demand for protection against losses has increased after more than $1.3 trillion has been added to American share values since the S&P 500 reached a five-month low on June 1. Equity volume reached the lowest level since 2008 excluding holidays this week as vacationing traders awaited U.S. Federal Reserve Chairman Ben S. Bernanke’s speech at the Kansas City conference in Jackson Hole, Wyoming, and the European Central Bank meeting next month.
“We are certainly in the summer doldrums -- both volume and volatility have been extremely low,” Andrew Greeley, a senior managing director at Stamford, Connecticut-based Acorn Derivatives Management Corp., which manages more than $500 million in volatility assets, said in an interview yesterday. “Many of the macro risks are still with us. We suspect that volatility will move back up.”
Shares outstanding for Barclays Plc’s iPath S&P 500 VIX Short-Term Futures ETN (VXX), the most traded of the securities tied to volatility, jumped sixfold this year to 142 million yesterday, data compiled by Bloomberg show. The number of ProShares Ultra VIX (VIX) Short-Term Futures shares increased to almost 50 million from 100,000 at the end of December, and the VelocityShares Daily 2x VIX Short Term ETN (TVIX) soared to 80 million from 5.1 million.
The securities track a gauge based on VIX futures. Exchange-traded notes are unsecured bank debt backed by their issuer’s credit, unlike exchange-traded funds that hold assets. Banks create and redeem shares of ETNs based on the level of demand for the securities. That demand generally doesn’t affect the price since the ETNs track the performance of an index.
The U.S. economy cooled in the second quarter as limited job growth prompted Americans to curb spending while state and local governments cut back. In the euro region, expansion shrank in the second quarter after the worsening debt crisis and tougher budget cuts forced at least six nations into recessions. China’s export growth collapsed in July and imports as well as new yuan loans trailed estimates.
Global gross domestic product will increase 2.2 percent this year, the slowest expansion since the 2009 contraction, the median economist estimate in a Bloomberg survey shows.
The S&P 500’s rally since June has taken the benchmark gauge for American equities close to its highest level since May 2008, amid speculation the Fed will add stimulus measures. The VIX, which moves in the opposite direction of stock prices about 80 percent of the time, fell 44 percent since this year’s high on June 1 and is 38 percent below its one-year average, data compiled by Bloomberg show.
The Federal Open Market Committee on Aug. 1 reiterated its pledge to ease policy further if necessary, and ECB President Mario Draghi promised last month that policy makers will do whatever is needed to preserve the euro. Bernanke’s speech at the 2010 Jackson Hole conference set the stage for a second round of large-scale asset purchases, which the committee started in November that year. His presentation this year takes place Aug. 31. The next Fed statement will be on Sept. 13, and the ECB will give its rate decision on Sept. 6.
The cost of bearish S&P 500 options has fallen to its lowest level in 14 months relative to bullish contracts. Puts that pay should the index drop 10 percent cost nine points more than calls betting on a 10 percent rally, three-month implied volatility data compiled by Bloomberg show. The price relationship known as skew fell to 8.73 on July 18, its lowest level since May 2011.
“A VIX below 15 is a nice headline and the market has seen a pick-up in options activity because of it,” Scott Maidel, who helps oversee $152 billion as a money manager for equity derivatives at Russell Investments in Seattle, said yesterday in an interview. “A lot of fund managers and hedge funds were light on exposure and hedging the upside, therefore volatility skew has come down.”
VIX futures show traders are betting volatility won’t stay this low. The six-month contracts reached their highest level since March versus the volatility index on Aug. 13, data compiled by Bloomberg show. At the same time, the number of outstanding VIX calls to buy the gauge versus puts to sell jumped to 2.08-to-1 on Aug. 10 after touching 2.2 on July 30, a one-year high, according to the data.
“It’s summer and nobody wants to own volatility,” Peter Cecchini, global head of institutional equity derivatives at New York-based Cantor Fitzgerald LP, said in an Aug. 13 interview. “The macroeconomic backdrop is completely divergent from the VIX and that disconnect is likely to revert.”
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