As U.S. equities push toward new record highs, CBOE Volatility Index-related exchange traded products are revealing an increasingly complacent market.
Over the past three months, the iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) fell 35.8%, ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) decreased 35.8%, VelocityShares Daily Long VIX Short-Term ETN (NYSEArca: VIIX) dropped 35.7% and REX VolMAXX Long VIX Weekly Futures Strategy ETF (BATS: VMAX) decreased 43.4%.
The CBOE Volatility Index, or so-called VIX, is now hovering around 10.6, its lowest since July 2014.
With equity markets pushing to new highs, some investors are betting on a sharp reversal.
Investors “are pricing in more volatility than normal on the downside” for stocks than the upside, Joe Tigay, a managing director at Equity Armor Investments, told the Wall Street Journal.
For example, traders recently threw $204 million of fresh money, the most since October, into the largest VIX-related product, VXX, according to FactSet data.
Meanwhile, the ratio of puts, or bearish options, to bullish calls on the CBOE Volatility Index is at its lowest in the past year, indicating that investors are wary of quick swings after the rally in U.S. markets following President Donald Trump’s affect on riskier assets.
The increased bets on the VIX come even after the volatility index remains stuck well below statistical thresholds that go back two decades, according to FactSet data. While the risk-on attitude is ramping up, the calm may be deceiving.
Volatility “usually doesn’t happen when people are expecting it,” Tigay added.
“There’s too much complacency” in U.S. markets, Vincent Chailley, chief investment officer at London-based H2O Asset Management, told the WSJ. “Any bad surprise from Mr. Trump means there’s a little to make but a lot to lose.”
Additionally, another signal that suggests a potential reversal is the crowded trade on betting on falling volatility. Hedge funds and other large speculators raised net short positions on the VIX to the largest level since September 6, betting on lower volatility or continued equity market momentum.
“When you have such short net positions in the market, it’s considered a red flag for the volatility market,” Ramon Verastegui, managing director at Société Générale, told the WSJ.
The accumulated short positions can lead to a short squeeze, Verastegui warned. “If you have a small spike in volatility, [volatility]can potentially move up really, really quickly.”
For more information on the CBOE Volatility Index, visit our VIX category.