Volatility Traders Shed VIX Positions as Markets Are Eerily Calm

  • Assets in largest volatility note VXX down 16% this year
  • ProShares VIX-tracking ETF lost 94% of its value in 2016

With the financial markets strangely quiet, investors in volatility are finally getting fed up with losses and abandoning their positions.

Barclays Capital’s iPath S&P 500 VIX Short-Term Futures Exchange-Traded Note, which goes by the symbol VXX and is the largest ETN linked to the Chicago Board Options SPX Volatility Index, also known as the VIX, has lost about 16 percent of its assets this year, according to Bloomberg data. Other exchange-traded products that track the VIX also have shrunk as investors give up on an expected surge in fear that never seems to come.

“It looks like investors might be tiring a bit,” said Rocky Fishman, an equity derivatives strategist at Deutsche Bank AG in New York. “In the past, when the VIX was flirting near low levels, people were a bit more optimistic on some type of VIX rebound, so they bought additional shares to maintain their position sizes.”

The VIX reached multiyear lows in 2016, but investors continued to pile into volatility-tracking products, betting on a spike in volatility that would send such securities soaring. The index jumped in June during U.K.’s vote to leave the European Union and then quickly fell back. It also surged in November leading up to the U.S. presidential election before tumbling back again.

Shares outstanding in the ProShares Ultra VIX Short-Term Futures exchange-traded fund, symbol UVXY, swelled by more than 1,000 percent in 2016, according to Bloomberg data. But after losing 94 percent of its value last year the growth has slowed dramatically, with shares outstanding climbing by only around 15 percent this year, according to Bloomberg data.

While some of the losses in these funds are due to the VIX, which sank to a three-year low in January, the structure of the products doesn’t help either. The securities hold future contracts that must be “rolled” to maintain their exposure. And the process is more costly when the futures curve steepens, making the contracts more expensive.

Move To Gold

“All else equal, this is about the worst time you could own VXX because the VIX futures curve is pretty steep,” said Jim Strugger, head of derivatives products for MKM Holdings LLC.

Roll costs have always been a problem for VIX-tracking securities, but investors still embraced volatility products because the payoff could be huge. For example, over two days in August 2015, when a selloff in Chinese shares set markets on edge, UVXY surged 83 percent, according to Bloomberg data.

However, such spikes are becoming increasingly rare. Anxiety surrounding the election of President Donald Trump and uncertainty about his policies barely dented the VIX. While the index has “plenty of upside potential, it could remain low and stable around the current levels for a while longer,” Strugger said.

In response, investors may be chasing gold, according to Eric Balchunas, an ETF analyst for Bloomberg Intelligence. The precious metal can be held longer-term and gives inflation hedge to boot. Holdings of SPDR Gold Shares, the biggest gold ETF, have climbed by around 5 percent in the last two weeks to 837 metric tons, according to Bloomberg data.

But Balchunas has a warning for investors rotating out of volatility and into gold -- when the going gets tough the returns may not be there.

“Gold will not go up nearly as much as a VIX ETP when the sky is falling,” he said.

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