Short Sellers Fleeing Inverse VIX Fund After 24% Rally

One of the best trades in the stock market this year has been betting on lower volatility, and by one indicator, it’s going to stay that way.

Short sellers are abandoning an exchange-traded fund that becomes more valuable during times of market tranquility after it soared 24 percent this year. Bearish bets on the fund, known as the VelocityShares Daily Inverse VIX Short-Term ETN, make up

0.2 percent of outstanding shares, a record low, compared with 19 percent in June, according to data compiled by Markit Ltd.

U.S. equity prices are stable because the economy is accelerating at the same time as the Federal Reserve is promising to keep interest rates near zero and the European Central Bank is preparing more stimulus measures to spur growth, according to Randy Frederick of Charles Schwab Corp. While the Chicago Board Options Exchange Volatility Index rose last week, it’s still about four points from an all-time low.

“There just aren’t a lot of catalysts out there that could cause the markets to get derailed,” Frederick, managing director of trading and derivatives at Charles Schwab, said by phone from Austin, Texas. “That’s the consensus perspective among the institutions out there right now.”

VIX Notes

Ways to speculate on how calm the stock market will be have expanded in the last decade with the advent of exchange-traded notes tied to the VIX. Strategies include relatively simple hedges against equity losses, such as owning a security that mimics the volatility gauge. The most popular of those, the iPath S&P 500 VIX Short-Term Futures ETN, saw 41 million shares change hands Sept. 12 and ranks among the most-heavily traded U.S. securities.

A more complex instrument is the VelocityShares Daily Inverse VIX Short-Term ETN, or XIV, which as its name implies moves in the opposite direction of the VIX. The fund, with average daily volume of almost 9 million shares last week, represents a bet that is similar to owning stocks. After losing 12 percent in July as the Standard & Poor’s 500 Index slipped

1.5 percent, both rebounded in August. The ETN slid 2.5 percent at the close in New York.

Markit data tracks companies and ETFs included in the securities lending programs operated by custodian banks. Synthetic ETFs and certain ETFs with low institutional holdings generally have less securities lending trading as brokers can source shares from ETF creations.

Record Profits

The XIV may be supported if record corporate profits keep bolstering investor confidence. S&P 500 earnings are projected to rise 8 percent in 2014, then climb 11 percent in 2015, according to analyst estimates compiled by Bloomberg.

“As long as corporate earnings continue to stay stable or rise slightly, then stocks can stay stable as well,” Frederick said.

The VIX gained 10 percent last week to 13.31, posting a third weekly advance. Measures of prices swings in the currency and Treasury markets also increased. The Bank of America Merrill Lynch MOVE Index, which measures price swings based on Treasury options, was up 8.9 percent last week and JPMorgan’s Global Volatility Index for currencies added 17 percent.

“Volatility in the U.S. equity market, relative to other global markets and asset classes, is remaining well-contained,” Neil Azous, founder of Rareview Macro LLC, a Stamford, Connecticut-based research firm, said in a phone interview.

Nervous Market

It’s been three years since the S&P 500 last suffered a 10 percent drop and valuations for the U.S. equity benchmark are near a four-year high. About 8.2 percent of the SPDR S&P 500 ETF Trust’s shares have been borrowed and sold to speculate on declines, up from 3.3 percent at the start of 2014, Markit data show.

“The market is very close to an all-time high, and in that sense you could argue that people are nervous,” Jason Benowitz, a senior portfolio manager who helps oversee about $4.5 billion at Roosevelt Investment Group Inc. in New York, said in a phone interview. “It’s our expectation that the market will continue to climb this wall of worry.”

Better economic data is giving investors peace of mind, according to Bill Merz of U.S. Bank Wealth Management. Recent economic data showed retail sales climbed in August at the fastest pace in four months and prior readings were revised up as more hiring, stock-market gains and cheaper prices at the gas pump put Americans in the mood to shop.

“Domestic fundamentals are still very strong,” Merz, a strategist on the derivatives and structured products team, said by phone. U.S. Bank Wealth Management oversees about $120 billion. “There’s an increased sense of stabilization and normalization of the domestic economy.”

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