With risky bets back in play, stock sell­off re­vives ‘Vol­maged­don’ mem­o­ries

Gulf Times Business - - BUSINESS -

Months af­ter he lost mil­lions when an es­o­teric corner of fi­nan­cial mar­kets cratered in Fe­bru­ary, for­mer Tar­get Corp store man­ager Seth Golden is bet­ting against volatil­ity again.

Golden, who says wa­gers on mar­ket calm earned him mil­lions in the past six years, is among the in­vestors who have kept trad­ing com­plex fi­nan­cial prod­ucts linked to the Cboe Volatil­ity In­dex — Wall Street’s “fear gauge” — in the months since some of those prod­ucts blew up.

“The ma­jor­ity of ‘vol sell­ers’ were not dam­aged in Fe­bru­ary.

It was the Johnny-come-latelies and peo­ple who shouldn’t have been trad­ing volatil­ity in the first place,” Golden said. This mar­ket is back in fo­cus af­ter an­other rapid stock mar­ket slide pushed VIX to as high as 29 from early Oc­to­ber lows un­der 12, and given a grad­ual re­build­ing of trades bet­ting the volatil­ity will not last.

While many in­vestors smarted, oth­ers kept com­ing and be­tween March and Septem­ber, more than $1.2bn rolled into US-based ex­change-traded volatil­ity prod­ucts, ac­cord­ing to Reuters cal­cu­la­tions based on data from Fact­Set Re­search Sys­tems Inc, which tracks the in­vest­ments.

That com­pares with $1.7bn the month be­fore the early Fe­bru­ary “Vol­maged­don” when stocks sold-off briefly on fleet­ing in­fla­tion fears, the VIX shot up to 50 on Fe­bru­ary 6 from 18 the day be­fore, and some in­vestors lost over 90% of their in­vest­ment.

Golden, who gained promi­nence af­ter the New York Times pro­filed him in 2017 and now runs a web­site that of­fers ad­vice to traders, said that he had al­ready more than re­cov­ered his Fe­bru­ary losses as he kept bor­row­ing VIX ex­change-traded prod­ucts, sell­ing them and buy­ing them back when the price goes down.

Reuters could not in­de­pen­dently ver­ify his ac­count­ing.

Golden said he cashed in some of his prof­its be­fore the lat­est volatil­ity spike and now was wait­ing for the mar­ket to re­verse to get back in.

“These are the days I live for,” he said dur­ing the mar­ket sell­off this week.

The Fe­bru­ary crash sparked a de­bate whether the VIX in­dex and the re­lated prod­ucts were prone to ma­nip­u­la­tion and led to dozens of law­suits and on­go­ing probes into the mat­ter by US reg­u­la­tors.

Since then, both the Cboe ex­change, which owns the VIX in­dex, and is­suers of some of the re­lated prod­ucts have made changes they say should make the mar­ket less prone to vi­o­lent, hard-to-an­tic­i­pate swings.

The ex­change has mod­i­fied its auc­tions that de­ter­mine the price of VIX fu­tures to boost liq­uid­ity while the back­ers of some of the volatil­ity prod­ucts tweaked them to re­duce lever­age.

For ex­am­ple, ProShare Cap­i­tal Man­age­ment, back­ers of the widely used ProShares-brand vol prod­ucts, re­struc­tured one prod­uct so it would aim to move less in re­sponse to changes in the mar­ket, los­ing 0.5%, in­stead of 1%, when the in­dex it tracks in­creases by 1%.

So far, those steps seem to have worked.

The $370mn ProShares Short VIX Short-Term Fu­tures ETF, which tum­bled over 80% in a sin­gle day in Fe­bru­ary, sank 8.3% on Wed­nes­day, lost 4.6% on Thurs­day and re­bounded 3% on Fri­day morn­ing.

Early this month, Bar­clays an­a­lysts who ar­gued the Fe­bru­ary plunge was “tech­ni­cal in na­ture” wrote that a strong US econ­omy and so far lim­ited eco­nomic im­pact from trade con­flicts, emerg­ing mar­ket cur­rency de­clines and up­com­ing con­gres­sional elec­tions should sup­port the short-vol trade.

This week, how­ever, they said their views have changed given an in­creased chance of a Fed­eral Re­serve pol­icy mis­step and in­vestors’ in­creased fo­cus on the ef­fects of a trade war be­tween the United States and China.

“We ex­pect volatil­ity to re­main el­e­vated in the short term and do not rec­om­mend buy­ing this dip,” they wrote.

“The dif­fer­ence is that this time there are some gen­uine cat­a­lysts we can point to,” one of the au­thors, Ma­neesh Desh­pande, told Reuters.

While in­vestors trade VIX fu­tures to guard against mar­ket de­clines and tur­moil, those de­riv­a­tives have a ten­dency to lose value in steadily ris­ing mar­kets as de­mand for such pro­tec­tion de­clines.

In­verse-vol prod­ucts launched and listed on ex­changes af­ter the 2007-2009 fi­nan­cial cri­sis al­lowed in­vestors to take ad­van­tage of that and profit dur­ing ex­tended spells of mar­ket calm.

Orig­i­nally de­signed as a so­phis­ti­cated hedg­ing tool for pro­fes­sional in­vestors to help man­age their daily mar­ket ex­po­sure, in­verse-volatil­ity prod­ucts be­came pop­u­lar among small in­vestors when the prod­ucts listed on ex­changes and took on a new life as a lu­cra­tive bet on mar­ket calm.

Gains of nearly 600% over two years up to Fe­bru­ary vaulted the prod­ucts onto var­i­ous lists of top per­form­ing in­vest­ments and made them the sub­ject of ex­cited con­ver­sa­tion on so­cial me­dia and fi­nan­cial web­sites.

“The pros, a lot of them were right back in there a week or two af­ter Fe­bru­ary,” said Rus­sell Rhoads, head of de­riv­a­tives re­search at TABB Group LLC.

“There’s lots of peo­ple try­ing to pick stocks.

The ma­jor hedge funds are all do­ing the same thing, and the volatil­ity space has opened things up for peo­ple that are will­ing to do the work to find a new way to spec­u­late on the mar­ket.”

Some an­a­lysts blamed the sever­ity of the crash in part on ex­ces­sive lever­age and overconfidence of ill-pre­pared re­tail in­vestors.

“It’s more or less a sub­sti­tute for go­ing to Las Ve­gas — you can do it from your home of­fice,” said Robert Wha­ley, a pro­fes­sor at Van­der­bilt Univer­sity who devel­oped VIX.

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