DERIVATIVES-VIX shorts hit new record

3 min read
Helen Bartholomew

Net short positioning in the CBOE’s VIX volatility index futures has hit record highs, despite Wall Street’s “fear gauge” marking its lowest close since July 2014 as it ended Friday’s session at 10.58.

The latest Commitments of Traders report from the CFTC, released on Friday, showed that speculators including hedge funds and asset managers held a net short of -134,224 VIX futures contracts – beating the previous record of -133,731 contracts that was reached in September 2016.

The data show that the absolute volume of short contracts actually declined to 282,860 from 291,203 during the week to January 24, but the fall was offset by a larger drop in long positions to 148,224 from 158,784.

While extreme positioning is in part a function of hedging activity around structured products, the short volatility carry trade – which monetises the gap between implied and realised – is still proving lucrative despite the VIX recording its second-lowest intra-day print since 2007 as it touched 10.30 on Friday.

According to data from Societe Generale, one-month implied volatility on the S&P 500 was trading at 9.2% as of January 24 - a hefty 46% premium to realised vol, which was stuck at 6.3%. Three-month implied volatility on the index traded at a 33% premium to realised.

While some believe that investors should be using the current low levels to switch into long volatility trades that position for an array of political uncertainties on the horizon, traders note that the carry trade is typically more profitable during times of low volatility.

“Most P&L is made selling vol in a low vol environment,” said an equity structuring head at a US house. “Implied vol tends to follow realised vol, but at some point implied finds a level and it never goes lower. At times of low volatility, it’s not impossible to capture a seven–vol spread.”

Analysts believe that volatility will tick higher through 2017, responding to the myriad uncertainties that include the impact of US President Donald Trump’s pro-growth policies, European elections and the UK’s negotiations to exit the European Union.

“While we continue to think a Trump victory likely means higher US growth in 2017 than we would have expected three or six months ago, we still think volatility will be a feature of the year,” said Jim Reid, strategist at Deutsche Bank in a client note this morning. “It just seems that there are too many uncertainties, unknowns and major policy changes attached to a Trump presidency for it to be a smooth year.”

The impact of Trump’s nationalistic policies – which have been largely ignored in equity markets to-date – were evident this morning as the VIX jumped 6% in European trading hours to 11.30. The moves followed a weekend of demonstrations across US airports as Trump’s executive order on immigration took effect, banning people from seven Muslim-majority countries from entering the US.

Volatility spikes may be exacerbated by extreme short positioning, as traders discovered in August 2015. At that time, the VIX jumped to a high of 53.29 as sellers rushed to cover their short positions amid a China-induced equity sell-off. Just prior to the events, VIX shorts totalled 175,000 contracts for a net position of -55,000. Within a month, net positions were aggressively reversed, jumping into record positive territory of 38,000 contracts.