Posts Tagged ‘VIX’

Hedge Funds Trade Volatility

March 18, 2010

Chidem Kurdas

Going long on volatility made a lot of money in 2008 and lost a bundle in 2009. Now, it sounds like many people are braced for another upsurge in vol.

Hedge funds are using exchange-traded notes linked to the VIX Index to make bets. The iPath S&P 500 VIX Short-Term and Mid-Term Futures exchange-traded notes (VXX and VXZ on NYSE Arca) are relatively novel instruments offering a low-cost way to go long or short volatility. ETNs are debt securities, but like ETFs they can be shorted.

Hedge funds account for 20% to 30% of the trading in VXX and VXZ, says Michael Schmanske, head of index volatility trading at Barclays Capital. Institutions account for another 30%. These are trading vehicles, not holding products, he said, speaking at a conference.

He sees uncertainty about what will happen when the Federal Reserve starts to withdraw volatility as driving people to buy VIX futures contracts and the VIX  ETNs. If volatility declines again, of course, owning the VIX will turn into a big-time losing trade as it did in 2009—VXX went down 75% in the past year.

But the ETNs  are better than owning S&P puts, Mr. Schmanske says.

iPath S&P 500 VIX Mid-Term ETN targets a weighted average futures maturity of 5 months while the short-term ETN targets maturity of one month. Volatility arbitrageurs use them to make spread bets, but others take directional positions. Some long/short equity funds have hedged their portfolio by buying the VIX.

Where does a volatility investment belong in a diversified portfolio? Some argue that volatility is an asset class that should have its own portfolio allocation.  Most investors, though, don’t treat volatility as an asset in itself but use it as a measure of risk.