How Volatility Trades Shifted at a Record Speed Speculators now hold the largest bet in favor of the VIX on record

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1 This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit MONEYBEAT How Volatility Trades Shifted at a Record Speed Speculators now hold the largest bet in favor of the VIX on record Traders signal o!ers in the VIX pit at the Cboe Global Markets, Inc. exchange on February 6, 218 in Chicago, Illinois. PHOTO: SCOTT OLSON/GETTY IMAGES By Jon Sindreu Feb 12, 218 8:53 am ET Investors bet on calm markets shifted to a record trade in favor of volatility last week, new data shows, a move that unleashed a wave of selling that analysts say fueled the worst equity rout in years. After a long period of market calm, many investors were betting against swings in equities through futures on the Cboe Volatility Index, or VIX, which tracks how much volatility investors expect on the S&P 5. They did that by selling VIX futures to insure against market swings, taking up the profitable role of insurer. When markets turned, investors scrambled to offset the damage either by buying back those futures or selling stocks, which drop as volatility increases overwhelming the market with sellers. That sudden shift from selling VIX futures to buying them was loud and clear in Page 1 of 5

2 weekly data from the U.S. Commodity Futures Trading Commission released Shifting Bets Net position on the VIX held by speculators using futures, by number of contracts 1.thousand late Friday. Speculative investors, or those classed as non-commercial by the CFTC, swung from a net 6 thousand contracts that wagered against the VIX the week before the market turned, to an 86 thousand-contract bet in its favor by last Friday. That s both the largest ever shift in these positions by speculative investors and their biggest bet in favor of the VIX since records start in 26. Since 216, investors have been betting on low volatility, forcing banks to take the other side... Net position on the VIX using futures, by number of contracts 2.thousand Asset managers Leveraged funds Dealers CFTC data is important because it typically reflects trends throughout the market. A closer look at the figures also shows some interesting trends that were at the center Page 2 of 5

3 of last week s rollercoaster ride in global markets. The CFTC breaks down investors in terms of dealers, which are mostly banks providing clients with a counterparty for their trades, asset managers, which include steady institutional investors like pension funds and insurers, and leveraged funds investors, which are hedge funds and other speculators similar to the noncommercial category....but volatility returned to the market after years of calm... Cboe Volatility Index Source: FactSet Over the last few years, speculators have doubled down on their bets against the VIX, in expectation that the long period of calm markets would continue and forcing dealer banks to take the other side of those trades. Analysts say that this can mellow market swings in itself, as banks offset these exposures by buying stocks as they fall and selling them as they rise. This can create a feedback loop in which betting against volatility suppresses it. The CFTC numbers show that even institutional investors who have usually been the main buyers of insurance against sharp market moves began moving the other way in 216, forcing banks into even larger positions in favor of the VIX. In late 217, even the likes of pension funds were net sellers of insurance as they looked to cash in on what had been a profitable trade. Last week, it all sharply corrected, with asset managers and speculators scrambling for insurance to offset their misfired bets, and banks selling that insurance bets on the VIX that the market will be volatile at high premiums. The feedback loop reversed, analysts say, as expensive insurance drove investors to offset their losses by betting against the S&P 5, both through futures and by selling actual stocks, because stock markets usually fall as volatility rises. CFTC data shows that as speculators launched their bets in favor of the VIX last week, they simultaneously started betting heavily against the S&P 5. Page 3 of 5

4 There s one bit of good news in the CFTC numbers: It suggests many investors have already offset their losing bets. An analysis by statistical research firm Quant Insight finds that the VIX s moves are now once again explained by economic and stockmarket trends, which hadn t been the case in 217, as the market was inundated by new volatility sellers. Some analysts warn, however, that a large chunk of the so-called short-volatility trade could still be unaccounted for....and investors were forced to buy VIX futures... Price of VIX futures maturing a number of months into the future. A downward sloping curve signals more demand than supply for short-term protection Now Two weeks ago Source: FactSet...But also sell stocks in order to o!set losses Net position by speculators on the S&P 5 using futures, by number of contracts 2.thousand Share this: Page 4 of 5

5 CFTC VIX VOLATILITY Copyright 217 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit Page 5 of 5