Traders revive short vol bets

IFR 2278 6 April to 12 April 2019
4 min read
Christopher Whittall

Investors are piling back into trades that profit from markets remaining calm – including strategies that blew up spectacularly early last year – as an about-face from central banks has quashed volatility across asset classes.

Bets that the CBOE’s Volatility Index or VIX, often referred to as Wall Street’s fear gauge, will stay low have reached the most extreme level among speculative investors in more than six years, according to analysis from Nordea.

At the same time, assets are on the rise in exchange-traded products designed to make money from a subdued VIX. Credit Suisse and Nomura each had to close down short VIX products last February after a sharp jump in volatility triggered spiralling losses.

A rise in bets on volatility remaining subdued across government bond and currency markets is testament to how the US Federal Reserve’s pivot away from raising interest rates has brought about a dramatic shift in markets since the start of this year.

“It’s a worrying sign,” said Andreas Steno Larsen, senior global strategist at Nordea.

“The interest is definitely there broadly speaking across asset classes. I consider that a natural result of the U-turn we’ve gotten from central banks.”

Financial markets have rallied fiercely since the Fed and other central banks signalled they were in no hurry to raise interest rates earlier this year. The MSCI World Index has had its best start to the year since 1998, while a surge in bond prices means US$9.5trn of global debt now has negative yields, according to Bank of America Merrill Lynch.

That comes after a dismal end to 2018, when equities and corporate bond markets tumbled. After rising as high as 36 points in early January, the VIX is now around 13 points following a collapse in equity volatility. Interest rate and currency volatility has also slumped.


Strategies that generate income when volatility is low – often broadly referred to as carry trades – tend to proliferate when investors expect markets to remain calm. In derivatives markets, investors such as pension funds and multi-asset funds express this view by selling options contracts. These options will rise in value if volatility increases – along with uncertainty over future asset prices – but make money for the seller if volatility stays subdued.

“This relatively calm environment is certainly propitious for [carry trades]. There was a period when you could get a decent yield in sovereign bonds and that’s no longer the case,” said Edmund Shing, global head of equity derivative strategy at BNP Paribas.

However, Shing is cautious on outright bets that equity volatility will remain low, not least because of the number of geopolitical risks on the horizon and the stingy premium you’re paid for such trades.

“Going short volatility is a very risky trade today,” he said.

Kokou Agbo-Bloua, global head of flow strategy and solutions at Societe Generale, said many clients were looking for strategies that would cap their downside losses if there was a spike in volatility.

“People are aware that just selling options without a Plan B could be dangerous,” he said.

The large proportion of speculative traders shorting the VIX is a worrying sign, though, along with the increase in assets in product that replicate that strategy. The largest, the ProShares Short VIX Short-Term Futures ETF, has seen assets grow 28% this year to US$441m, according to Morningstar.

That’s not to say it’s one-way traffic. Tobias Knecht, who manages funds at Assenagon that profit from volatility jumping, said he has seen quite significant inflows this year and a noticeable pick-up in client meetings.

“There seems to be an increasing appetite going into long volatility strategies … mainly driven by the volatility in the last quarter of 2018,” he said.

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