The U.S. stock market’s main volatility gauge -- the CBOE Volatility Index, better known as the VIX -- is at its lowest level since 2007. That seems strange in light of the geopolitical anxiety surrounding the French elections, the saber rattling with North Korea and the mixed fiscal and economic signals coming from the U.S.
While gallons of ink have been spilled on whether the VIX is “broken,” some traders are now suggesting that exchange-traded products linked to the index have a hand in the perceived distortion. What’s more, they warn, their popularity -- VIX ETPs have absorbed $700 million this year -- could exacerbate a selloff if volatility spikes.Long-VIX ETPs “roll” contracts to maintain their exposure. Each day they’ll sell the front-month contract and buy more of the second-month contract. This can suppress the price of the front-month and raise the cost of the second -- steepening the front end of the curve into an upward slope known as a contango. While no one is saying that ETPs alone can alter the curve, steepness has increased with the uptick in the products’ assets.
Maximum gain at expiration (VIX at 22 or above): $380
Maximum loss at expiration: substantial if VIX falls to zero; if VIX stays above an 11 put strike price but below 18, we lose the premium of $20.
Entry: today using the ticket
Stop: we will pull out if the VIX falls below 9
Target: 22 or above
Time horizon: 26 days
While gallons of ink have been spilled on whether the VIX is “broken,” some traders are now suggesting that exchange-traded products linked to the index have a hand in the perceived distortion. What’s more, they warn, their popularity -- VIX ETPs have absorbed $700 million this year -- could exacerbate a selloff if volatility spikes.Long-VIX ETPs “roll” contracts to maintain their exposure. Each day they’ll sell the front-month contract and buy more of the second-month contract. This can suppress the price of the front-month and raise the cost of the second -- steepening the front end of the curve into an upward slope known as a contango. While no one is saying that ETPs alone can alter the curve, steepness has increased with the uptick in the products’ assets.
Maximum gain at expiration (VIX at 22 or above): $380
Maximum loss at expiration: substantial if VIX falls to zero; if VIX stays above an 11 put strike price but below 18, we lose the premium of $20.
Entry: today using the ticket
Stop: we will pull out if the VIX falls below 9
Target: 22 or above
Time horizon: 26 days