Volatility Spikes Offer Inverse Play on S&P 500

Investors have been basking in the sunlight of a year-end market rally in 2023 that appears to be continuing in 2024 after a slow start to January. However, a Fed that’s keeping rates steady amid hotter-than-expected inflation is allowing volatility to spike, but offers a potential inverse ETF play for traders.

The prime volatility indicator, the Cboe Volatility Index, or simply the VIX, is up over 25% for the year. The VIX has seen momentary spikes so far in 2024, as interest rate cuts that investors were hoping for in 2024 continue to be pushed back.

In the meantime, the Direxion Daily S&P 500 Bull 3X Shares ETF (SPXL) is still up about 12% for the year, but when volatility spikes, it could offer traders the opportunity to take the other side. As volatility returns to the markets, Wall Street traders may be exiting short positions on the VIX. In turn, this could spell bad news for the S&P 500. It also harkens back to 2018, when volatility reached voluminous levels.

“A popular trade that triggered a historic market meltdown back in 2018 made a comeback last year, as one barometer of its performance logged its best year in six,” a MarketWatch report said, noting that an unwinding of bets on less volatility could trigger a sell-off, thereby crushing the current rally.

“But as with any successful trade on Wall Street, some derivatives-market experts now fear that shorting volatility, or being ‘short vol,’ has become overcrowded, increasing the risk that a sudden spike in the Cboe Volatility Index VIX, or the VIX, could spark a selloff that might send the S&P 500 tumbling,” the report added.

^VIX Chart

^VIX data by YCharts

Investor Worries Return

Of course, a major cause of volatility as of late has been the return of the higher-for-longer interest rates narrative. Rate cuts already priced into the rally late last year may be pushed back while a data-dependent Federal Reserve exercises patience on loosening monetary policy.

In the meantime, given that inflation pushed higher than expected during the month of January — stoking fears that rate cuts may not come, or worse — rate hikes could resume. As CNBC reported, the producer price index jumped 0.3% last month, logging its largest increase since August. That also paired a higher-than-expected consumer price index reading in January.

“Both data have stoked investor worries on whether inflation is firmly under control,” the CNBC report said.

As volatility rises, it poses opportunities for inverse plays on the S&P 500. To profit on the downside in the short term, traders can use the Direxion Daily S&P 500 Bear 3X ETF (SPXS). The fund seeks daily investment results equal to 300% of the inverse of the daily performance of the S&P 500 Index.

For more news, information, and strategy, visit the Leveraged & Inverse Channel.