Traders are piling into one of the world’s most dangerous ETFs
Speculators are again piling into an exchange-traded note that lets them bet on how long days of calm will last in the U.S. stock market.
The trade, using a six-year-old security known as VXX that sees more average daily volume than shares of Microsoft Corp. and Facebook Inc., has usually backfired amid the biggest bull market since the 1990s. That hasn’t curbed its popularity, with the iPath S&P 500 VIX Short-Term Futures ETN poised for an eighth straight week of inflows, a streak not seen in three years. Shares outstanding in the note are at an all-time high.
Bears are betting this time will be different with the Standard & Poor’s 500 Index flat for the year and stuck at the same level it reached in November. Owning the note could pay off should any number of concerns, from declining corporate profits to conflict in the Middle East, open the door to volatility in a stock market that has been mostly immune to it.
“It just feels like there’s a bit more of a worry that something could go awry,” said Steve Sosnick, an equity risk manager at Timber Hill, the market-making unit of Greenwich, Connecticut-based Interactive Brokers Group Inc. “The winning streak of the buy-the-dips strategy could be coming to an end, as all winning streaks do.”
Ways to speculate on how noisy the stock market will be have exploded in the last decade with the advent of products tied to the Chicago Board Options Exchange Volatility Index. Strategies include relatively simple hedges against equity losses, such as owning a security that aims to mimic the VIX.
VXX, one of the most popular ways to bet on bigger market swings, has absorbed $715 million in seven consecutive weeks of inflows, its longest streak of inflows since one ending in July 2012. The infusion of fresh cash has continued this week, swelling its market value to $1.5 billion, the highest since September 2013.
At the same time, short-sellers in VXX — people effectively betting the bull market will persist — have dropped out. Short interest has slid 35 percent since October, falling to the lowest in more than seven months last week, data compiled by Markit Ltd. show.
Sustained gains in U.S. stocks have proven elusive. The S&P 500 has dropped 2.3 percent this week, posting at least three straight days of losses for the fourth time in 2015. The measure has gone 27 days without advancing in back-to-back sessions, the longest stretch since 1994.
The S&P 500 rose 0.1 percent to 2,058.34 at 9:38 a.m. in New York. The VIX dropped 1.5 percent to 15.56.
Traders have had to contend with a resurgence of turmoil in the Middle East, signs that U.S. company profits are in freefall and decreased buybacks from corporations as the first-quarter earnings season begins in April. Muddled messages from the Federal Reserve have spurred hedging, according to Justin Golden at Lake Hill Capital Management LLC.
“There are lots of different ways to hedge equity exposure at this critical time when investors are trying to interpret every word out of the Fed to gauge when rates lift off,” Golden, a partner at Lake Hill, wrote in an e-mail. His firm trades options on equity indexes and commodities. “Currently, VXX is the preferred method.”
Past surges in the VIX note’s popularity have been less than prescient in predicting more turbulence. Shares outstanding in VXX climbed to multiple records throughout 2013, a year when the S&P 500 gained 30 percent and U.S. shares posted one of the broadest advances in history. A high on July 24, 2014, came just before a 3.8 percent August rally in the equities gauge.
Daily fluctuations in U.S. stocks have made this retreat seem more painful than it actually has been, according to Dominic Salvino at Group One Trading LP, a market maker for VIX options. The S&P 500 is down just 2.9 percent from a record reached March 2 and the U.S. benchmark gauge has already endured declines of this magnitude three times in 2015.
“There’s still not a heavy panic out there,” Salvino, a specialist on the CBOE floor for Group One Trading, said by phone Thursday. “You’re not seeing a whole lot of fear. It seems like a lot, but we’ve been up for three consecutive years and we’re still in the 2,100 range.”
The VIX climbed 2.3 percent to 15.8 on Thursday, below its average of 16.65 for 2015. Futures on the volatility gauge expiring in April ended Thursday at 16.48, according to data compiled by Bloomberg. Contracts expiring in May closed at 17.83, while June futures ended the day at 18.28.
To U.S. Bank Wealth Management’s Bill Merz, the interest in VXX is indicative of a change in mindset among investors about stocks’ resilience as monetary policy diverges and other markets show signs of weakness. Positions held in the three largest exchange-traded products appreciating with VIX futures have more than doubled since the beginning of the year, Bloomberg data show.
“There’s been a big shift occurring in volatility ETFs and ETNs,” Merz, a strategist on the derivatives and structured products team at U.S. Bank, said by phone. His firm oversees $126 billion. “It appears as though investors are moving back to a long volatility bias versus a short one. VXX is the biggest indicator of that.”