Traders Brace for End of Quiet After VIX’s Biggest Drop: Options

Traders in one of the most popular exchange-traded notes tracking volatility are convinced the calm in U.S. stocks won’t last.

Investors added $514 million in February to the iPath S&P 500 VIX Short-Term Futures ETN, known by its ticker symbol VXX, for its biggest monthly inflows since July 2013. The note appreciates as futures on the Chicago Board Options Exchange Volatility Index climb.

The VIX, a gauge of market turbulence tied to options on the Standard & Poor’s 500 Index, posted its biggest drop ever last month as a Greek bailout deal, stabilization in the price of oil and dovish language from the Federal Reserve carried equities to fresh records. While the market continues to rally as obstacles dissipate, traders are taking the opportunity to reload on bets for higher stress through VXX.

“The market has short-term complacency,” Dominic Salvino, a specialist on the CBOE floor for Group One Trading LP, a market maker for VIX options, said by phone. “Right now, there’s near-term quiet, but they’re thinking we could get a return to a volatile environment in at least April or May.”

New Positions

The VIX slid 36 percent in February as the S&P 500 jumped 5.5 percent, its best month in over three years. Shares of the VXX dropped 25 percent in the period.

Traders saw the drop in volatility as an opportunity to open positions in the largest funds benefiting from bigger market swings. The iPath note absorbed more than half of February’s inflows in the last week of the month as its size swelled by 10 million shares, the most of any week since it began trading in 2010, Bloomberg data show.

The VIX jumped 6.3 percent to 13.86 at 4 p.m. in New York. The VXX rose 2.2 percent to $27.28.

Shares outstanding in VXX, the VelocityShares Daily 2x VIX Short Term ETN and the ProShares Ultra VIX Short-Term Futures exchange-traded fund increased 72 percent last month to 263 million on Feb. 27, a record for positions in all three products. Historically, a rise in traders’ interest in these funds has preceded spikes in equity volatility, according to Jason Goepfert at Sundial Capital Research Inc.

“When shares outstanding rise quickly, it has coincided with declining volatility and a VIX that was about to rise in the months ahead,” Goepfert, president at Sundial in Blaine, Minnesota, wrote in a Feb. 27 note. “Based on the recent jump in the shares outstanding, this should be a negative for stocks.”

The VIX has climbed above 20 on five occasions since the last time shares outstanding advanced to a record on December 10. The S&P 500 has recorded three declines of 3 percent or more since then.

Swings Calm

Speculators also removed cash in February from the biggest ETN profiting from market calm. In that period, the VelocityShares Daily Inverse VIX Short-Term note, or XIV, lost $421 million in outflows, its worst month of withdrawals since May 2013.

U.S. equities calmed down last month after a volatile January, when swings in the S&P 500 nearly doubled from 2014. Data Feb. 6 showed employers in the U.S. added more jobs than forecast in January, while oil rebounded and conflicts in Greece and Ukraine were resolved.

Concern over the effect of tightening monetary policy on risk appetites eased after Federal Reserve Chair Janet Yellen said Feb. 25 inflation and wage growth remain too low for the central bank to raise rates at its next meeting.

“The potential for volatility to spike has been pushed out in time until somewhere in June” with Greece’s current program for debt negotiations expiring then, Max Breier, a senior equity-derivatives trader at BMO Capital Markets Corp. in New York, said by phone. “Until then, there don’t appear to be any obvious catalysts for volatility to pick up again.”

Catalysts Disappear

Hedge funds and other large speculators in VIX futures have pared back their bets on higher volatility, now owning more bets on a lower VIX relative to a higher one, according to data compiled by the Commodity Futures Trading Commission. These investors held about 120,000 short positions in the contracts and 113,000 long ones, CFTC data through Feb. 24 show.

The VIX slid 2.3 percent to 13.04 on March 2, as the Nasdaq Composite Index closed above 5,000 for the first time in 15 years and other equity benchmarks reached all-time highs.

Futures on the volatility gauge expiring March 18 ended Monday at 15.33, 18 percent above the VIX’s closing price, according to data compiled by Bloomberg. Contracts expiring in April closed at 16.98, while May futures ended the day at 17.43, the data show.

“People may be taking an outright stance on volatility, since VXX is one of the easiest and quickest way to do that,” Eric Metz, a derivatives strategist and fund manager at RiverNorth Capital Management LLC, said by phone. “In February, the markets rallied quite dramatically and volatility compressed an equally alarming amount.”

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