VIX Stress Signal Telling Even Worse Story Than the Stock Market

  • S&P 500 volatility gauge surged 43 percent over two days
  • VIX speculators were shortest since 2013 heading into selloff

The current slump in the U.S. stock market would look like a full-blown selloff if all you had to go by was the Chicago Board Options Exchange Volatility Index.

Signals from the VIX have been downright dire over the last week or so, as relatively small retreats in the S&P 500 Index get amplified through the lens of investor stress. The VIX rose 16 percent on Friday and 23 percent yesterday, the biggest two-day move since the depths of the August rout. Its 1.5 percent increase at 12:20 p.m. in New York sent the gauge to an almost four-month high.

While a lot is occupying investors minds of late, analysts say the swings in the volatility gauge are being exacerbated by speculators who were caught off guard when U.S. stocks failed to break to new highs last week. Now those investors are buying protection in options and futures markets before Britain’s upcoming vote on European Union membership and the Federal Reserve’s next steps, according to Steve Sosnick of Timber Hill LLC.

“You had people acting like the market wasn’t going to go down again,” said Sosnick, an equity risk manager at the market-making unit of Greenwich, Connecticut-based Interactive Brokers Group Inc. “There was a level of complacency and imperviousness to news around the world. Somebody is not buying the VIX back out of choice -- they’re doing it because they have to.”

As of June 7, hedge funds and large speculators held more short bets on VIX futures than at any time since 2013, according to data from the U.S. Commodity Futures Trading Commission. The VIX has increased in every trading session since then, rising 55 percent over the period, the biggest five-day gain of 2016.

The S&P 500 fell 1.7 percent over Friday and Monday, the worst two-day stretch for the index since February, while the VIX spiked 43 percent. The last time the benchmark fell that much the reaction in the VIX was more muted, with the gauge climbing just 19 percent.

“If you looked at VIX and you couldn’t see anything else you would guess the S&P was probably down 2 percent or more, and it wasn’t even down a percent,” Peter Tchir, head of macro strategy at Brean Capital LLC, said in an interview on Bloomberg TV’s “What’d You Miss” on Monday. “So many markets are trading these products now, and each for their own reason, I think you get a few more dislocations like that.”

Signs of cautiousness abound in equity markets. Traders currently have 5.7 percent of their capital parked on the sideline in the form of cash, the most since November 2001, according to a fund manager survey compiled by Bank of America Merrill Lynch.

Nervousness can also be seen in the one-month implied volatility on the S&P 500, which sits at the highest since August relative to 30-day realized volatility, according to Bloomberg data. Worry has also pervaded implied volatility contracts on the VIX itself, with the CBOE VVIX Index rising 38 percent over Friday and Monday, the most since the August selloff for a period of that length.

Leveraged notes tied to the VIX may have also helped drive the volatility gauge’s steep increase during the past week, according to Macro Risk Advisors. Holders of these VIX instruments must buy futures on days the S&P 500 gains, and sell on down days. This can exacerbate sudden moves in the VIX in either direction, they said.

On Monday holders of leveraged VIX notes had to buy 42,400 futures. That was the most in history for the practice, known as rebalancing, according to data compiled by MRA.

“The larger the move, the more they need to trade,” Pravit Chintawongvanich, head derivatives strategist at MRA, wrote in a client note on Tuesday. “This can lead to a vicious cycle where a spike in volatility leads to anticipatory buying.”

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