February rout, redux? Exotic ETF trading surges again

LONDON: The prime suspects in last month’s global rout may be at it again.

Inverse exchange-traded funds – which use leverage to bet against stocks and volatility indexes – have seen trading activity skyrocket to ominous levels as markets have whipsawed in the past few days.

In fact, turnover has only been higher two other times since the financial crisis: in 2016 during a correction and in February when a surging Cboe Volatility Index forced short funds to unwind.

The difference this time is that inverse leveraged technology ETFs are at the centre of the action, rather than volatility products.

There’s nothing necessarily odd about a pick-up in volume during periods of market stress.

Volatility begets ETF trading as investors hedge macro events using broad exposure.

What’s unusual here is inverse technology funds saw a more extreme jump in volume than those typically associated with turbulent markets.

Indeed, the SPDR S&P 500 ETF, ticker SPY, and the iPath S&P 500 VIX Short-Term Futures ETF, ticker VXX, had muted increases in value traded compared to inverse tech funds.

“One theory for SPY and VXX’s lack of heightened volume might be that the very big fish aren’t worried or are already hedged, and that the sort of mid-sized institutional crowd is playing this,” Eric Balchunas, a senior ETF analyst at Bloomberg Intelligence, said.

“It’s the quick buck trading group.” On average – over the four days through Tuesday – one inverse ETP share was traded for about every 50 shares traded on the US tape. Since 2013, the average volume over four days is half that, data compiled by Bloomberg show.

Among technology funds, a US$467mil ProShares ETF that shorts a three-times leveraged version of the Nasdaq 100 Index has traded about US$470mil per day in the four days through Tuesday, and then another US$674mil on Wednesday.

In the past two years, average daily turnover was US$140mil.

The jump in volume has an ominous historical parallel, according to Balchunas.

“If you just look at the tech-geared stuff doubling or tripling in volume, it’s the same way the financials leveraged ETFs traded in 2008,” he said.

“They owned the while.” — Bloomberg

One theory for SPY and VXX’s lack of heightened volume might be that the very big fish aren’t worried or are already hedged, and that the sort of mid-sized institutional crowd is playing. Eric Balchunas

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