All the money that has poured into volatility ETFs from nervous investors is influencing the market the products are designed to track: VIX futures contracts.
The spike in trading volumes for VIX futures in March “appears in large part due to the growing popularity of ETFs and notes, which are structured to generate returns as equity volatility rises,” the Financial Times reports, adding that the products have gathered $3 billion of inflows year to date. [Why Trading in VIX ETFs is Surging]
The rising use of volatility ETFs and ETNs has led to concerns the VIX could be sending “distorted messages” about future expectations of market behavior, according to the article. [Volatility ETFs Thumped]
Despite the popularity of volatility funds, they fell last month along with the CBOE Volatility Index, which touched its lowest levels since the summer of 2007. Additionally, they’ve been hit by “contango” in the VIX futures market. [VIX ETFs: Beware Contango]
There are lingering concerns that these funds are impacting the VIX futures market, which is in contango. Longer-dated futures are more expensive than the spot price, “suggesting that investors are worried stocks could stumble in the coming months,” according to the FT story.
“The VIX futures market is shallow, and so it can be easily distorted by one or two big funds,” said Steve Davenport, director of equity risk at Wilmington Trust.
“It is possible that these funds have created a class of investors that are long-only VIX futures, impacting the market,” added Lawrence Schulman, chief executive at Cheiron Trading, in the report.
When VIX futures are in contango, the volatility products lose money on the trade when they “roll” the contracts before expiration to maintain exposure.
“The action in the exchange traded products may be helping to drive that steep contango,” wrote Chris McKhann at optionMONSTER in a recent report.
“It used to be that steep contango in the VIX futures meant that smart money was betting on higher volatility in the near future, and they were usually right. But since 2008, and especially since the inception of the VIX exchange traded products 2009, the steep contango has not necessarily preceded equity selloffs,” McKhann added.
iPath S&P 500 VIX Short Term Futures ETN