Bloomberg News

VIX Squeeze Seen by SocGen as Short Bets Rise to Record

September 18, 2013

The next drop in U.S. equities may spur a bigger jump in the Chicago Board Options Exchange Volatility Index as investors rush to cover their record bets against the gauge, according to Societe Generale SA. (GLE)

Hedge funds and other large speculators have more than doubled short positions on VIX futures to 189,020 contracts since the end of June, according to data compiled by the U.S. Commodity Futures Trading Commission. The wagers reached a record last month. The current figure implies those investors may lose $99.5 million with every 1 point increase in the volatility gauge, CFTC data show.

This year’s rally in U.S. stocks has led to a 19 percent plunge in the VIX, creating profitable strategies to bet against volatility futures. A decline in equities and subsequent increase in share-price swings would bring losses for VIX short sellers, which may drive them to cover the trades, according to Ramon Verastegui of Societe Generale. Increased demand for the contracts will push volatility higher and may exacerbate the stock-market selloff, he said.

“The concentrated short in the VIX futures is like a red point if you look at a map of the market, signaling potential risk,” Verastegui, head of engineering and strategy at the French bank, said in a Sept. 13 interview from New York. “A short squeeze in the VIX will have an impact on the volatility market and that can spill over into other markets, accelerating a move down in the S&P 500.”

VIX Futures

The last time investors were close to being this short VIX futures was in February, CFTC data show. The VIX, tracking options on the Standard & Poor’s 500 Index, surged 34 percent on Feb. 25, the most since August 2011, after U.S. lawmakers struggled to reach an agreement to avoid spending cuts and Italian elections were inconclusive. Investors reduced short holdings on the VIX contracts through the next four months, according to the CFTC measure.

The number of short VIX positions initiated by hedge funds reached almost 222,000 futures in August, an all-time high, CFTC data show. The benchmark of stock-market volatility added 1 percent to 14.53 yesterday. It closed 2.4 percent below its average for the past year. The mean since 1990 is 20.26.

Volatility Strategies

Bets against volatility have risen as investors take advantage of a market in contango, where prices increase into the future. In the strategy, investors buy longer-dated futures and sell nearer-month futures. Just before expiration of the short future, the investor covers the position by buying it back and selling a new short-dated future at a higher price.

The trade is profitable in low volatility environments when the contango remains steep.

Two-month futures trade at 16.32, 5.4 percent more than those expiring in a month, data compiled by Bloomberg show.

Growing speculation about the Federal Reserve’s tightening of economic stimulus has whipsawed stocks since May, when officials first indicated reductions could start this year. The S&P 500 tumbled 5.8 percent from a record on May 21 through June 24. It rebounded 8.7 percent to close at its latest all-time high before slumping as much as 4.6 percent from that level.

Analysts are divided on the amount by which the Federal Open Market Committee will reduce its monthly bond buying today. Of 64 economists surveyed by Bloomberg News, 33 predicted that the Fed will lower its purchases of Treasuries by $5 billion or less, while 31 forecast a cut of $10 billion or more. Some 57 percent of investors predicted that the markets would not change suddenly if the central bank starts to taper, according to a poll of 900 fund managers, traders and analysts who are Bloomberg subscribers on Sept. 10.

‘Incredibly Resilient’

“The equity market remains incredibly resilient,” Gary Flam, a portfolio manager at Bel Air Investment Advisors LLC in Los Angeles, said in a Sept. 16 phone interview. His firm oversees about $7 billion. “Shorter-term managers were cautiously positioned coming into September as you had a laundry list of concerns, but as we move through the month these fears are either being checked off or reduced.”

Tensions over Syria have eased after the U.S. reached an agreement with Russia to eliminate Syria’s chemical weapons. Under the accord, reached in Geneva, President Bashar al-Assad has a week to submit a list of his inventory of toxic arms.

The VIX, which moves in opposite direction to the S&P 500 about 80 percent of the time, tends to fall in September in years when volatility is below its current historical average at the start of the month, data compiled by Bloomberg show.

Futures Trading

The volatility benchmark fell 0.8 percent to 14.42 at 9:49 a.m. in New York today. In Europe, the VStoxx Index, which tracks the cost of options on the Euro Stoxx 50 Index, closed at 18.99 yesterday, 2.3 percent below its one-year average. It slipped 0.4 percent to 18.91 today.

Trading of VIX futures has averaged about 160,500 contracts per day this year, data compiled by Bloomberg show. That’s the most ever and 69 percent more than the volume in 2012. There are about 416,000 futures outstanding, according to the data.

“A short-term move down in the S&P 500 could be exacerbated by short-covering in VIX futures,” Trevor Mottl, Susquehanna Financial Group LLLP’s New York-based head of derivatives strategy, said Sept. 16 by phone. “A lot of people think the world is fine, and they’re selling VIX futures.”

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Cecile Vannucci in London at cvannucci1@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net; Andrew Rummer at arummer@bloomberg.net


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