Bets on low market volatility went spectacularly wrong

By The Economist online

THE Cboe Volatility Index, or Vix, known as the “fear gauge”, spikes when markets are most jittery. When Sandy Rattray, now at Man Group, an asset manager, worked on the Vix in the early 2000s, he and his team considered launching an exchange-traded product (ETP) linked to it, but concluded that it would be a “horror show” because of poor returns. Now, however, Vix-linked ETPs are a big industry, with around $8bn in assets. Formerly niche investments, they served vastly to exacerbate this week’s market turmoil, which saw the Vix’s largest ever one-day move, when it more than doubled on February 5th.

The Vix was always intended as a basis for financial products as well as a gauge. Vix futures were launched in 2004 and options in 2006. “Long” Vix products, which Mr Rattray looked into, seek to mirror the index . The problem is that this means buying futures contracts, with buyers having to pay a constant premium over spot prices. So these ETPs tend to lose money over time, punctuated (but not fully made up for) by gains when the Vix spikes. The largest “long” fund, VXX, issued by Barclays, has lost over 99.9% since its launch in 2009.

So other ETPs were developed to “short”—ie, bet against—the Vix index. Until this week, they were doing handsomely. Amid a long spell of subdued volatility, investors piled in. In January, assets in…

…read more

Read more here: Bets on low market volatility went spectacularly wrong

Category: Business and finance, Incoming, Finance and economics, FINANCE

Leave a Reply

%d bloggers like this: