As volatility wanes, investors have been betting against the CBOE Volatility Index with inverse exchange traded products. However, some are beginning to hedge against a complacent market, issuing a warning on potential short-term risks.
Betting against spikes in market volatility has been a winning idea so far this year. For instance, the VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV), ProShares Short VIX Short-Term Futures ETF (NYSEArca: SVXY) and VelocityShares Daily Inverse VIX Medium Term ETN (NYSEArca: ZIV) were among six ETFs that touched all-time highs Wednesday. Year-to-date, XIV is up 6.4%, SVXY is up 6.5% and ZIV is up 9.9%.
The Chicago Board Options Exchange Volatility Index, or simply the VIX, is a gauge of implied volatility on S&P 500 index options. Essentially, the VIX strengthens when volatility increases or when equities begin tanking.
On the other hand, a short or inverse VIX strategy essentially provides investors a bet that a calm and complacent market environment will continue.
The VIX dipped 5.4% Wednesday and now hovers around 12.3, close to its lowest level since the financial crisis and 14.7% below its 200-day simple moving average. Historically, the index has sat around the 15 to 20 level.
“I am of the view that we are in a period of lower volatility and people need to reset their expectations of what high volatility really is,” Eric Augustyn, head of options strategy for Wells Fargo Private Bank, said in a Bloomberg article. “If there is a floor on the VIX, it’s 10.”
However, some short sellers are beginning to exit bets against the VIX, growing wary a complacent market. The below-average economic growth, slowing corporate earnings and uncertainty over the Federal Reserve could push up market volatility.
For instance, bets against the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX), the largest volatility-based exchange traded note that tries to track the VIX index, have declined to 25% of shares outstanding from a record 126% in February. [A New King Among Volatility ETNs]
“There’s some fear out there,” Justin Golden, a partner at Lake Hill Capital Management LLC, said in the article. “The danger of being short the VXX is if the world blows up and something happens, it’s going to be pretty painful.”
For more information on the CBOE Volatility Index, visit our VIX category.