Investors Betting More Volatility Is Coming

$VXX

The US stock market has been relatively calm this year, disappointing investors betting billions on volatility.

The CBOE Volatility Index, or VIX (NYSEArca:VXX) is down about 30% YTD, even though there is the expectation that the Fed is ready to raise interest rates as this 6-year-old Bull Market slows.

Volatility low because no one is talking in “panic.”

YTD about $1.9-B flowed into ETFs betting on a rise in volatility, while some $1.1-B has flowed out of ETFs betting on a drop in volatility, based on FactSet data, they have been punished for those wagers.

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The biggest long volatility-focused ETF, the iPath S&P 500 VIX Short-Term Futures ETN, for example, has attracted $766-M in new investments this year, while it is down about 40%. At the same time, money has been flowing out of ETFs that bet on low volatility. The VelocityShares Daily Inverse VIX Short-Term ETN, for example, is up 45% this year, but has seen $680-M in outflows.

Much of the money flowing into volatility ETFs likely comes from professional participants who are using them to hedge their long bets and may be jumping in and out of them.

Those plays come at a price, especially for retail investors who tend to keep positions for longer periods of time.

Retail investors tend to use these things as a gambling product, while institutional investors employ a more sophisticated hedging strategy.

If you’re betting on a spike in volatility, you had better be right quickly, if you’re wrong, you’re going to get eaten up. It is an expensive bet.

That is because these funds are constantly replacing expiring futures contracts with new ones. When the new contracts are more expensive than the ones being sold, aka contango in the futures markets, the funds lose money on both ends of that transaction.

Contango is currently at about 8%, which means that investors buying a long VIX fund would need the VIX to rise more than 8% to hit a positive return.

In addition, the funds cost more than a typical stock or bond exchange-traded fund, with the VXX, for example, charging 0.89% of assets per year in management fees.

People have a higher fear of what’s going to happen than what actually happens and are willing to pay for insurance.

Volatility is not something that’s sustainable.

HeffX-LTN Analysis for VXX:	Overall	Short	Intermediate	Long
HeffX-LTN Analysis for VXX:	Bearish (-0.33)	Neutral (-0.15)	Bearish (-0.40)	Bearish (-0.46)