- As the US stock market has been mired in turmoil, one trade has stood head and shoulders above the rest — and it may not be what you think.
- The strength of the strategy is a reversal from 2017, when an inverse version of it was crowned Business Insider's trade of the year.
When the stock market gives you lemons, make long-volatility bets.
If you've heeded this advice this year, it has most likely been a lucrative approach. After all, as major US indexes have tested multimonth lows — including the tech-heavy Nasdaq 100 erasing its year-to-date gain entirely on Monday — volatility-linked products have surged.
Those include the ProShares Ultra VIX Short-Term Futures ETF (UVXY) and the VelocityShares Daily 2x VIX Short Term ETN (TVIX), each of which has more than doubled in 2018. And then there's the iPath S&P 500 VIX Short-Term Futures ETN (VXX), which has spiked more than 85%.
All three vehicles derive their price from the Cboe Volatility Index, or VIX, and allow traders to bet on or against an imminent rise in stock market price swings. And all three have returned far more than even the best-performing stocks in the benchmark S&P 500 this year. Even the index-leading Nektar Therapeutics — up more than 65% — has been put to shame.
Perhaps even more remarkable than the outperformance of these VIX instruments is the 180-degree turn they've made since the start of the year.
In late 2017, the so-called short-volatility strategy, which amounts to a wager on market placidity, was crowned as Business Insider's stock market trade of the year after surging more than 200%. Now, just three months later, the opposite bet is the one making loads of money for traders.
And while an increase in the VIX means a decline in the S&P 500 roughly 80% of the time, there are most likely many experts across Wall Street applauding the resurgence of the long-volatility trade. For months, people like Marko Kolanovic — who helms JPMorgan's global quantitative and derivatives strategy — called foul on the shorting of volatility, likening it to the conditions leading up to the 1987 stock market crash.
Overall, his argument echoed that of many Wall Streeters — which was that VIX products were being traded in reckless fashion as investors attempted to get rich quick. And that devil-may-care attitude caught up with them, when two short-volatility trades imploded in February amid market turmoil.
And while that reckoning ended up temporarily worsening a stock sell-off, some argue it was actually a long-term positive, because it wiped out a major pressure point for the market.
So the next time you're at a loss for which stock market trade to make, take a long, hard look at the volatility complex. If you time it right and understand the proper mechanics of the VIX, there's some serious money to be made. Just make sure to get the direction right.
