“As more money is invested in these products, the operators have to buy up more VIX futures contracts and the cost is passed on to investors,” Nikolaos Panigirtzoglou, a senior analyst at JPMorgan, said in the Financial Times article. “The investors buying these products are typically retail investors – you wouldn’t see a hedge fund using a strategy like this for downside protection.”
Fund providers would have to take on more futures contracts as investors throw more money into the VIX funds. For instance, the iPath S&P 500 VIX Short-Term Future ETN (NYSEArca: VXX) saw its shares outstanding increase rapidly.
“The VIX futures market is very thin,” Davenport, added. “People on the other side of the trade know that the banks operating these funds have to cover their positions and can price accordingly.”
For more information on volatility-linked funds, visit our VIX category.
Max Chen contributed to this article.