Friday, March 7, 2014

An Awful Lot of People Are Shorting Volatility (VIX; VXX; XVIX; XXV)

I'm starting to wonder if Izabella likes posting on volatility because, in addition to talking to Chris Cole who is pretty sharp, the ETP symbols read like Roman numerals?

As to the headline, I mean "awful lot" in both the colloquial and the literal.

From FT Alphaville:
Why the new shoeshine boy trade is shorting volatility
Crowded trade alert.

Chris Cole, of volatility fund Artemis Capital, has an insightful piece in the latest edition of the CFA Institute Conference Proceedings Quarterly warning about one of the most popular trades of recent times: the shorting of volatility via Vix ETPs.

The speculative shorts on Vix futures as a percentage of open interest, for example, are already running at an all-time high. In Cole’s mind this now equates to the shoeshine boy trade of the modern era.
One of the ironies, he also notes, is that the trade simply synthesizes a much less efficient version of a 3-4 times leveraged position on the S&P 500.

From the piece:
On a risk-adjusted, equal volatility–weighted basis, the return on a strategy of consistently shorting volatility on the front of the volatility term structure using the XIV ETN is lower than the return on holding the S&P 500. Since November 2010, the annual return on the S&P 500 is 14.26%; for the risk-adjusted XIV ETN, it is 9.16%.

The annual volatility for both—with the XIV risk adjusted to the S&P 500—is 17.41%. So by holding the S&P 500, an investor could have earned a higher return per unit of risk than by holding this short volatility ETP, which has large drawdowns during sharp volatility rises.

In the end, shorting volatility is just a leveraged version of index beta. The problem when many “shoeshine boys” are shorting volatility is that the volatility of VIX futures dramatically outpaces the volatility of the VIX dur­ing the last 15 minutes of the trading day when all the structured products rebalance....