VIX Traders Pile Into S&P 500 Rebound Bets as Puts Jump

Traders are making unprecedented use of the options market to bet on a rebound in U.S. stocks.

Ownership of puts on the Chicago Board Options Exchange Volatility Index reached a record 3.2 million on Feb. 6, according to data compiled by Bloomberg. Money poured into the bets against the VIX after the gauge, used by investors as insurance against share losses because it rises when equities fall, climbed to a 13-month high of 21.44 last week before collapsing to 15.29 by Feb. 7.

The trading shows some investors have been unconvinced that turmoil in emerging markets and signs of slowing growth in the U.S. and China would spur lasting declines in the Standard & Poor’s 500 Index. That speculation paid off when the benchmark gauge for American equities had its biggest two-day rally since October on Feb. 6 and 7.

“People who bought the dip in equity have been right,” Philippe Trouve, the VIX options trader and director for equity derivatives at Bank of America Corp. in New York, said in an interview on Feb. 7. A record 2.38 million VIX contracts changed hands on Feb. 3, data compiled by Bloomberg show.

The S&P 500 lost 5.8 percent from its Jan. 15 record of 1,848.38 through Feb. 3 amid signs of a contraction in Chinese manufacturing and as Argentina’s decision to allow the peso to devalue triggered a rout in emerging-market currencies. The Federal Reserve’s second reduction of monthly bond-buying added to investor uncertainty.

VIX Retreats

CBOE’s VIX, which moves in the opposite direction of the S&P 500 about 80 percent of the time, jumped 77 percent in the three weeks after Jan. 10, when a U.S. jobs report disappointed traders. It retreated 23 percent on Feb. 6 and 7 as the benchmark gauge for American equities rose 2.6 percent to 1,797.02 as U.S. company earnings exceeded analyst estimates and data showed the U.S. unemployment rate fell. The VIX fell 0.2 percent to 15.26 today.

Ownership of puts on the VIX has risen 23 percent since Jan. 21, Bloomberg data show. Open interest in calls fell 14 percent to 7.2 million after reaching an all-time high of 8.4 million three weeks ago.

Bets on a decline in volatility also pushed record money into an exchange-traded note that rises in value as stock-market swings narrow. Assets in the VelocityShares Daily Inverse VIX Short-Term ETN doubled over the past two weeks to $810 million on Feb. 7, according to data compiled by Bloomberg. The ETN, known by its ticker XIV, rallied 16 percent to $30.33 in the last two trading days.

‘Fade’ Volatility

“In hindsight, it was the right short-term trade to fade the volatility,” Neil Azous, a founder of Stamford, Connecticut-based research firm Rareview Macro LLC, which advises investors including hedge funds and money managers, said in an interview on Feb. 7. “It’s partly a function of the retail players calling for lower volatility and this is the instrument they can transact in versus actual shorting volatility using VXX.”

It’s the first time that the inverse VIX note has surpassed assets in the iPath S&P 500 VIX Short-Term Futures ETN, which trades under the ticker VXX and gains when stock fluctuations widen. The iPath security lost as much as 37 percent of the money invested since Jan. 24, pushing its market value to a two-year low of about $745 million on Feb. 6, while its shares retreated 16 percent to $45.46 since Feb. 5.

Volume in iPath’s VIX ETN soared to a record 79 million notes on Feb. 3, while it was about 46 million for the inverse VIX product, the second-highest daily total since it began trading three years ago.

Share Creation

Shares outstanding on the inverse VIX note from VelocityShares have more than doubled in 2014 to almost 27 million, data compiled by Bloomberg show. That compares with a decline of 32 percent to 15.4 million on Feb. 6 for the iPath note. A daily average of about 14 million and 36 million shares respectively changed hands on the two VIX products in the past 30 days, putting them among the most-traded securities on U.S. stock exchanges.

Volatility may return to equity markets vulnerable to contagion from developing economies and a possible slowdown in the U.S., according to Randall Warren, chief investment officer of Warren Financial Service in Exton, Pennsylvania.

‘Second Wave?’

“The way market panic happens is not usually all at once, it’s like waves on the beach,” Warren, manages more than $100 million including options, said last week via phone. “The first wave crashed on the beach on Monday when the S&P 500 dropped,” he said. “That wave is going to recede and the market is going to go back up. The question is, is there ever going to be a second wave?”

The equity benchmark lost 2.3 percent on Feb. 3 for the biggest retreat in seven months after economic reports showed American factory output expanded in January at the weakest pace in eight months and China’s official Purchasing Managers’ Index decreased to a six-month low as production and orders slowed.

The ten most-owned contracts on the iPath VIX note were puts betting on lower volatility, according to data compiled by Bloomberg. January 2016 $20 puts, with an exercise price 56 percent below the last close, had the largest ownership followed by January 2015 $20 and January 2015 $15 put contracts, the data show.


VelocityShares’ XIV has tripled since its launch in November 2010, while the VIX security from iPath has almost erased its value since launching in January 2009, Bloomberg data show. Its returns have been hurt by an advance of as much as 173 percent in the S&P 500 since its low in March that year, a decline in volatility amid record Fed monetary stimulus and a price structure of VIX futures known as contango, when contracts with later delivery months cost more than nearer-dated ones.

“Obviously this is a great way to play volatility collapsing,” Alec Levine, an equity derivatives strategist at Newedge Group SA in New York, said in an interview. “Similar exposure in betting against higher volatility would equate to a short VXX position, which technically has unlimited risk. Given the two options, similar exposure with limited risk is clearly more attractive to many market participants.”

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