The equities market continues to rise toward record highs while volatility has dipped to record lows. However, in a complacent market condition, more traders may be looking at the CBOE Volatility Index and related exchange traded funds to hedge a potential turn ahead.
Open interest in calls on the CBOE Volatility Index, a bearish equities trade and widely considered the best gauge of market fear, recently outnumbered puts by four to one, Bloomberg reports.
The rising interest for risk hedges as shown on open interest for calls on the VIX suggest that more people are growing wary of the extended bull market environment and are hedging their bets with VIX options in case of a sudden, precipitous turn.
Reflecting the rising complacency in the equities market, the VIX recently dipped below 9, touching a record low of 8.84, which beat the low of 8.89 from December 27, 1993, CNBC reported.
The volatility index has steadily declined to lows not seen in over two decades as U.S. equities pushed higher, triggering concerns that when market volatility strikes, the VIX will spike significantly.
“The market’s very lax,” Lee Ferridge, head of macro strategy, North America, State Street Global Markets, told CNBC. “The chance of a rate hike this year are marginally reduced. It’s positive for stocks and the VIX has declined.”
Nevertheless, traders who are wary of the extended bullish conditions can look to VIX-related exchange traded products to hedge their exposure in case of a sudden fallout.
For instance, VIX traders may look to the iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY), VelocityShares Daily Long VIX Short-Term ETN (NYSEArca: VIIX) and REX VolMAXX Long VIX Weekly Futures Strategy ETF (BATS: VMAX).
The VIX, or so-called fear index, is a widely observed indicator for investor sentiment in the stock market and measures the expected or implied volatility of large-cap stock options traded on the S&P 500 index. ETPs that track VIX futures allow investors to profit during rising volatility or hedge against short-term turns. VIX exchange traded products track the VIX futures market, not the VIX spot price.
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The bearish or inverse VIX ETF, the REX VolMAXX Inverse VIX Weekly Futures Strategy ETF (BATS: VMIN) has also been one of the best performing ETFs this year due to the ongoing risk-on environment and falling VIX. The reason VMIN has been doing so well may be attributed to a quirk in the way the ETF structure works.
With the popularity of inverse VIX ETFs grows, many think of volatility funds as having a significant decay in price. While this is generally true of long volatility funds, VMIN takes the other side of the trade, benefiting from such decay as it accrues in exchange for bearing the risks associated with sudden spikes in volatility.
For more information on the CBOE Volatility Index, visit our VIX category.