Billions pour into ETFs selling options in huge bet on stock calm
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Their new form largely takes the shape of ETFs that sell options on stocks or indexes in order to juice returns. Assets in such products have almost quadrupled in two years to a record $64 billion, data compiled by Global X ETFs show. Their 2018 short-vol counterparts — a small group of funds making direct bets on expected volatility — had only about $2.1 billion before they imploded.
The bad news is that the positions — alongside a stack of less visible short-vol trades by institutional players — are suspected of suppressing stock swings, which invites yet more bets for calm in a feedback loop that could one day reverse. The strategies are also part of an explosive wider growth in derivatives that is introducing new unpredictability to the market.
But while the money involved looks bigger, derivatives specialists and volatility fund managers are so far brushing off the risk of another “Volmageddon,” as the 2018 selloff came to be known. In other words, the short-vol exposure itself is not a destabilizing force, even if such bets are vulnerable to turmoil themselves.
Hedge funds gaming relative volatility are also feeding the boom. One of the most notorious short-vol bets is an exotic options strategy known as the dispersion trade. Employing various complex options overlays, it amounts to being long volatility in a basket of stocks while wagering against the swings of an index like the S&P 500. To work, it needs the broader market to stay subdued, or at least experience less turbulence than the individual shares.
At Ambrus Group, another volatility hedge fund, an internal measure of vega aggregates options activity for the S&P 500 Index, the Cboe Volatility Index — a gauge of implied price swings in the US equity benchmark also known as the VIX — and the SPDR S&P 500 ETF Trust . Kris Sidial, co-chief investment officer, said in January the net short vega exposure was two times larger than in the run-up to the 2018 rout.
In its latest quarterly review published last week, the Bank for International Settlements said that dynamic was the likely reason behind the compression of volatility given the boom in strategies that eke out income from selling options. “The meteoric rise of yield-enhancing structured products linked to the S&P 500 over the last two years has gone hand in hand with the drop of VIX over the same period,” researchers wrote.
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