Traders appear to be preparing for a surge in US equity volatility with demand soaring for call options based on the Cboe Volatility Index.
Trading volumes for VIX call options indicate that traders are preparing for US equity market turbulence in the near term.
According to an article published in the Wall Street Journal (WSJ), average daily trading volumes during February for call options based on the Cboe Volatility Index, also known as the VIX, rose to levels not seen since the Covid-related stock market crash in March 2020.
The VIX is an index that measures the market’s expectation for volatility in US large-cap equities over the next 30 days. It is derived from implied volatility in near-term S&P 500 option contracts.
VIX derivatives, meanwhile, are liquid volatility products based on the VIX which allow investors to manage their volatility exposure independent of the direction of the stock market. Buyers of VIX call options typically wish to hedge against future stock market volatility – these options profit when the VIX rises beyond the strike price stipulated in the contract.
The VIX itself is still actually trading well within normal parameters with the index settling at a level of 18.49 at the market’s close on Friday 3 March – VIX readings below 20 are generally indicative of calm in the markets while readings above 30 highlight a significant degree of fear.
The VIX topped 30 on four separate occasions throughout 2022, highlighting the relative turbulence of that year as converging risks kept investors on edge including the ongoing war in Ukraine, stubbornly high inflation despite rapidly rising interest rates, and the potential resurgence of Covid in China.
Volatility expectations notably dropped off from October, however, with the VIX trading around the low 20s since early November as markets began to become more optimistic that the Federal Reserve would wind down its tightening cycle without having caused any serious damage to the US economy.
According to the WSJ, that optimism has been challenged in recent weeks by hotter-than-expected economic data that increases the likelihood that the Fed will be forced to continue raising interest rates for longer in order to bring down inflation. The WSJ notes that one of the most popular bets placed by options traders in February was for the VIX to reach 40 in the coming months, a level not seen since March 2020 (although the VIX surged even higher to a level of 66 during the initial Covid market crash).
Volatility ETPs
Investors who believe a surge in volatility is imminent may wish to buffer their portfolios using volatility-linked ETPs.
Volatility-linked ETPs staged somewhat of a comeback in the US in 2022 after several years of being shunned by the market after one of the largest products – the VelocityShares Daily Inverse VIX Short-Term ETN (XIV US) – effectively imploded during the February 2018 spike in US equity market volatility known as ‘Volmageddon’.
Two issuers – Volatility Shares and ConvexityShares – both debuted volatility-linked ETFs last year.
Launched in April 2022, the Volatility Shares 2x Long VIX Futures ETF (UVIX US) delivers twice (+200%) the daily performance of the Long VIX Futures Index which references a long-only portfolio of short-term VIX futures. The fund currently houses $160 million in assets and comes with a management fee of 1.65%, although the ETF’s prospectus document notes that total fees may be as high as 2.78%.
The ConvexityShares 1x SPIKES Futures ETF (SPKX US) and ConvexityShares Daily 1.5x SPIKES Futures ETF (SPKY US), meanwhile, debuted in August, providing regular (+100%) and lightly amplified (+150%) exposure to the SPIKES Volatility Index. The SPIKES Index is similar to the VIX but measures the implied expected 30-day volatility in the $360 billion SPDR S&P 500 ETF (SPY US). SPKX and SPKY come with expense ratios of 0.65% and 0.79%, respectively.
In Europe, Amundi’s €100m Lyxor S&P 500 VIX Futures Enhanced Roll (Lux) UCITS ETF (LVO NA) is one of the cheapest (as measured by expense ratio) means of obtaining VIX exposure. The fund tracks the S&P 500 VIX Futures Enhanced Roll Index, a second-generation volatility index that dynamically switches between short-term VIX futures and mid-term VIX futures, based on their relative implied volatility, to order to enhance cost efficiency. Its expense ratio is 0.60%.
Alternatively, the $20m WisdomTree S&P 500 VIX Short-Term Futures 2.25x Daily Leveraged ETP (VIXL LN) offers 225% leveraged daily exposure to short-term VIX futures. Its expense ratio is 0.99%.