Record Short VIX Notes Sounding Alarm to Deutsche Bank

Securities that usually gain value as the U.S. stock market gets calmer have never been more popular with investors. That concerns strategists at Deutsche Bank AG.

A combination of investor inflows and declining equity volatility has pushed the market value of the VelocityShares Daily Inverse VIX Short-Term ETN to about $1.2 billion and sent the ProShares Short VIX Short-Term Futures ETF to $564 million, data compiled by Bloomberg show. Both reached records last week.

Interest is building in the exchange-traded products as they recover from swoons that erased almost half their share price as markets buckled and the Standard & Poor’s 500 Index tumbled earlier this year. That could spell trouble, according to Rocky Fishman, an equity derivatives strategist at Deutsche Bank AG in New York. Another exodus could whipsaw traders and even exacerbate moves in the Chicago Board Options Exchange Volatility Index.

“The size of these short-volatility ETN products have come to be so gigantic,” Fishman, who is based in New York, said by phone. “People saw a lot of money being made on it, so there’s certainly the mentality out there that you’re at a better entry point now. The ’buy-the-dip’ mentality is being applied to the product and it shouldn’t be.”


About $544 million in inflows were added to the VelocityShares ETN last month, swelling its market capitalization from $622 million on Oct. 1, while the ProShares ETF absorbed $264 million, the highest monthly inflows for both products since they started trading.

Betting against volatility has been profitable for holders of the securities, who use them to hedge portfolios or speculate on the future path of the VIX, a gauge of volatility based on S&P 500 options prices. Shares of both have soared more than 400 percent since the end of 2011 as the VIX has plunged 40 percent.

Shares of both securities dropped 36 percent as signs of a slowing global economy and concern Ebola will spread erased more than $2 trillion from U.S. equity values between Sept. 18 and Oct. 15.

During that time, the VIX more than doubled to the highest intraday level since 2011, then dropped back down at the fastest rate since 2009. The short-VIX securities have rebounded 29 percent since Oct. 16.

’Mini Crash’

“The interest in the products has definitely picked up, especially after that mini-crash we had,” Dominic Salvino, who trades the ProShares ETF as a specialist on the CBOE floor for Group One Trading, said by phone. “They are sensitive and became popular leveraged bets to the point that if we recovered, they would see significant moves, and we did.”

The growth of the products, which are derived from short positions in VIX futures, could amplify the sense of panic in the market during a selloff, Fishman said.

Speculators in the securities have a record amount of money tied to this trade, which could backfire in the event of a prolonged spike in volatility. Investors in these two products will lose about $114 million for every 1-point increase in the VIX, according to Deutsche Bank data compiled Oct. 29. The measure, known as vega, climbed above $100 million for the first time this month.

“The outstanding size of exchange-traded VIX products, particularly the double-levered and inverse products, continues to be a concern,” Fishman and other Deutsche Bank strategists wrote in a note Oct. 29. “In a massive volatility spike, much of that may need to be covered quickly.”

Still, hedge funds owned more positions betting on higher volatility than lower volatility through the end of the month. Large speculators held about 107,000 long positions and 106,000 short ones through Oct. 28, according to data from the Commodity Futures Trading Commission.

Staying Power

The end of the Federal Reserve’s bond-buying program, a decision the central bank announced last week, could introduce more volatility into the market. When the Fed concluded its first round of quantitative easing in March 2010, the VIX more than doubled over the next two months, reaching a closing-level peak of 46. When the second round of QE ended in June 2011, the volatility gauge was near 16 and then jumped, averaging about 30 through the third quarter.

The VIX plunged 13 percent to 14.03 last week. Futures on the volatility gauge expiring in November ended last week at 15.8, 13 percent above the VIX’s closing price, according to data compiled by Bloomberg. Contracts expiring in December closed at 16.05, while January futures ended the day at 16.81.

The VIX climbed 5 percent to 14.73 at 4:15 p.m. in New York.

“Investors have been successful in selling volatility on spikes because hiccups in the market since 2011 have been short-lived,” Justin Golden, a partner at Lake Hill Capital Management LLC in New York, wrote in an e-mail. His firm trades options on equity indexes and commodities. “The risk in these strategies is position sizing. If the VIX gaps up and there are prolonged periods of chaos, investor staying power will be tested.”

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