Fed-Driven Complacency Sparks Record Streak Of VIX-Selling Inflows

Tyler Durden's picture

We are sure this will end well... As CDS-based credit ETFs are launched, so the number of ways to 'sell' volatility (buy complacency) for retail equity investors have exploded in recent years as The Fed's stranglehold on uncertainty has continued. However, as Bloomberg reports, as VIX has tumbled in the last few weeks, investors are wagering on further declines - in the five weeks through Aug. 15, they put almost $320 million into the VelocityShares Daily Inverse VIX Short Term ETN (XIV): the longest stretch of weekly investments since the note began trading in 2010.

The thinking, as SocGen notes, "given [The Fed's] ‘artificial cap’ on volatility, periods of correction are generally a good window to sell volatility." However, as history has taught us, "you have to worry about complacency..t’s been a Fed-induced calm," and won't last forever - ask the Japanese.

As Bloomberg reports, a soft touch on monetary policy will continue to suppress stock volatility, or so suggests the record stretch of cash going into an exchange-traded note that rallies as calm returns to equities.

Ways to speculate on how noisy or calm the stock market will be have exploded in the last decade with the advent of exchange-traded notes tied to the VIX. Strategies include relatively simple hedges against equity losses, such as owning a security that mimics the volatility gauge. The most popular of those, the iPath S&P 500 VIX Short-Term Futures ETN (VXX), saw almost 40 million shares change hands yesterday and ranks among the most-heavily traded securities of any variety in the U.S.

 

A more complex instrument is VelocityShares’s XIV note, which as its ticker symbol implies, moves in the opposite direction of the VIX. The ETN, with volume of 10 million shares yesterday, represents a bet that is similar to owning stocks. After losing 12 percent in July as the Standard & Poor’s 500 Index slipped 1.5 percent, both have rebounded in August, and shares outstanding of XIV have surged 33 percent this month, data compiled by Bloomberg show.

And shows no signs of slowing...

Bets against volatility show traders are conditioned to expect turmoil in the stock market to be brief. The VIX surged as much as 64 percent in July as shares slid for the first time in six months. Investors were quick to speculate the volatility index would fall back, as it has since 2012, Ramon Verastegui of Societe Generale SA said.

 

“Central bank accommodative policies tend to limit tail risks and therefore to prevent big market drawdowns and very high volatility spikes,” Verastegui, the head of engineering and strategy at Societe Generale in New York, said by phone. “Given this ‘artificial cap’ on volatility, periods of correction are generally a good window to sell volatility.”

 

Investors have also boosted bets against the biggest volatility exchange-traded product. Short interest on the iPath short-term futures note has jumped to 60 percent of shares outstanding from 19 percent in May, data compiled by research-firm Markit show.

But not everyone is buying it (or selling it per se)...

“What could be driving them is that the market has been resilient for many years,” said Cherry, senior vice president of derivatives trading at Chicago-based TJM. “I do feel as though we should be seeing volatility rise with tapering and geopolitical issues.”

 

“You have to worry about complacency,” Macey said. His firm oversees $82 billion. “You feel much more comfortable in markets when everyone’s worried, but it’s been a Fed-induced calm. It’s a calming of markets and giving people a sense of security.

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Picking up lots of pennies in front of the inevitable steamroller...

 

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Just ask the Japanese how QE vol suppression worked for them...