Stock Market Participants Who Bet on Volatility ‘Hammered’
For a very long time volatility in the stock market had remained at 30 year lows, as stocks rose to new all-time highs since the day after the 2016 Presidential election without a pullback (3-5%) or a correction (9-11%).
That is the longest stretch in market history without such actions
BlackRock Inc, (NYSE:BLK) the world’s biggest asset manager, urged more regulation of the inverse volatility-linked products that were hammered during a stock meltdown that saw $4-T in market value worldwide pared Monday.
Investors using exchange-traded products to bet on the VIX (VXX), Wall Street’s fear gauge which measures expectations for near-term S&P 500 swings, were hammered Monday when the index posted its biggest single-day rise since August 2015
Since the 9 March 2009 bottom, the popular trade on Wall Street was to ‘buy the dip and sell the VIX,’” which means that big investment houses, which also include large insurance companies, have purchased stocks at every opportunity and during every minor pullback.
Shorting the Cboe’s VIX, Wall Street’s fear gauge, was a bet that volatility would continue to stay low.
With the a record Bull Run and a lack of volatility, markets can either breakout, or breakdown.
In the last 14 months, we have seen both.
The US market is + 40% since 8 November 2016, and gained 8% in January alone.
Tuesday, New York Fed President William Dudley raised questions about whether some financial products tied to market volatility were well put together.
“Some of these VIX products, I think, people now are going to look at this with the benefit of hindsight and say, ‘Were these really well designed?
“This was not that big a bump in the equity market and these products actually blew up.”
The VIX index uses derivatives to track expected volatility in US stocks. After months of calm, VIX spiked over the last 5 day causing substantial losses for investors who had been making returns betting against its rise.
Mr. Dudley’s views were shared by his fellow central bankers who were not surprised by the Southside action, because they considered stock valuations stretched for a while.
The steep price decliner has shown few signs so far of posing much of a risk to the stability of the financial system or the durability of the economic expansion, that as explained by retiring Fed Chairwoman Janet Yellen as she left the cafeteria Monday for the last time.
“Corrections are healthy” after extended rallies, Dallas Fed President Robert Kaplan said Wednesday. “What I look at is whether it has implications for financial conditions or the health of the underlying economy and I would say, I don’t think so.”
After Tuesday’s close, the S&P 500 remained about 9% higher compared with its mark in late July 2017, when Fed staffers 1st deemed asset prices to be elevated.
Meanwhile, the Key danger with the VIX, and associated derivatives, is that they behave erratically when volatility explodes.
So, this Key risk in trading derivatives more suited for professionals than civilian market participants.
Those participants that suffered the steepest declines were those that used leverage, made concentrated bets in only a few stocks, or focused on thin slices of the market, all strategies that were richly rewarded during the 19% rally in the S&P 500 that left the index starting the year with record highs.
Non professional participants might be better off staying with more traditional ways of investing, meaning buy and hold great companies.
|NYSEArca:VXX||41.63||7 February 2018||-1.25||44.73||44.84||40.64||41,842,303|
|HeffX-LTN Analysis for VXX:||Overall||Short||Intermediate||Long|
|Neutral (0.21)||Neutral (0.22)||Bullish (0.32)||Neutral (0.10)|