Some investors are revisiting a popular trade that has largely been out of favor since last year’s market tumble: betting against stock market turbulence.
Assets in the ProShares Short VIX Short-Term Futures ETF , a popular vehicle for betting against stock market gyrations, have nearly doubled over the last six months to $562 million.
Investors have also reaped big gains betting against products designed to profit from volatile markets.
Short sellers targeting the Barclays iPath Series B S&P 500 VIX Short-Term Futures ETN logged paper profits of $319 million, or 48%, making VXX one of the most profitable shorted ETFs this year, S3 Partners data through May 14 showed.
Betting against volatility was a popular strategy in the months of placid trading leading up to the pandemic, until markets tumbled and volatility surged as COVID-19 spread around the globe.
More than a year later, “people are slowly coming back into it,” said Michael Purves, chief executive of Tallbacken Capital.
Volatility has steadily declined as the S&P has climbed 90% since its March 2020 nadir, with the Cboe Volatility Index (.VIX), known as Wall Street’s fear gauge, now hovering near a 15-month low.
Several factors are fueling investors’ bets that the market’s gyrations will remain contained. The Federal Reserve has doubled down on its commitment to maintaining unprecedented monetary stimulus despite a recent surge in inflation, while President Joe Biden’s administration is pushing trillions more to stimulate the economy.
Meanwhile, events with the potential to spark big market moves – such as last year’s presidential election and the Jan. 5 Georgia Senate runoff, are now in the rearview mirror.
“There are not a lot of events on the calendar,” Tallbacken’s Purves said. “Show me a giant volatility catalyst there.”
A countrywide vaccine rollout has also driven down coronavirus infections and helped fuel an economic reopening and rebound in growth.
Investors next week will be keeping an eye on Friday’s non-farm payrolls for clues on the progress of the economic recovery and pace of inflation.
Last month’s report showed U.S. job growth unexpectedly slowed in April, likely curbed by shortages of workers and raw materials.
Traders have also shown increased interest in recent sessions in selling equity options, both overwriting and underwriting – strategies that rely on calm markets, said Christopher Murphy, co-head of derivatives strategy at Susquehanna Financial Group.
“Volumes have dried up this week ahead of the Memorial Day weekend, and we are seeing major indices trade in tighter ranges and a notable trend of summer volatility selling,” he said, referring to both stock and options volume.
To be sure, betting against volatility can be a risky strategy.
One notable blowup came in February 2018, when a sharp fall in stocks cratered several short volatility exchange traded products, most notably the VelocityShares Daily Inverse VIX Short-Term exchange-traded note (XIV), which lost nearly $2 billion.
Many of the world’s biggest banks have also said trading may be more turbulent in the coming months as U.S. growth is expected to peak, with Goldman Sachs, Morgan Stanley and Deutsche Bank among those forecasting headwinds.
Seth Golden, chief market strategist at investment research firm Finom Group, who had been shorting ProShares Ultra VIX Short Term Futures ETF shares from last year has trimmed his position in recent weeks, wary that the Fed may send a hawkish message when global central bankers meet at the Jackson Hole Economic Symposium in August.
“Come then I think the opportunity to short volatility would be ideal,” he said.
Others, however, believe the time to bet against volatility has already arrived.
“We are in this in-between phase where volatility is low compared with where it has been in the past six months but it could go much lower,” said Jay Wolberg, founder of Trading Volatility, a data and analytics provider focused on volatility exchange traded products and financial derivatives.
Wolberg’s actively-managed $9 million Switchback Dynamic Volatility Fund 1, flipped to a net short volatility position in mid-May, after growing worries about a rise in inflation prompted a minor pullback in stocks.