Traders Were Already Rushing to Short Volatility Before Fed Cut

(Bloomberg) -- Just before the Federal Reserve's move to shore up confidence with an emergency rate cut, one of the bull market's hottest stock trades was already staging a spirited comeback.

By one metric, investors are shorting volatility with a fervor not seen for years, in the wake of an equity sell-off that sent an implied measure of fear soaring to the highest since August 2015.

After the swiftest market correction in history, the U.S. central bank delivered a half-percentage point interest rate reduction Tuesday to forestall the economic fallout spurred by the virus.

That could be just the ticket for the growing cohort of volatility shorts on Wall Street -- if the monetary medicine revives the bull market.

On Monday, the ratio between puts and calls on the CBOE Volatility Index rose to its highest since 2011, reflecting an avalanche of bets that the fear gauge will fall as tranquility returns. Nearly 2.5 put options, which theoretically gain in value if the VIX drops, were traded for every call contract.

After spiking as high as 49.48 on Friday, the VIX was trading at 31.96 at 10:30 a.m. in New York on Tuesday.

In the passive community, short interest in a leveraged VIX futures instrument has surged to the highest in more than a year -- a racy investing strategy that wins in market calm. Around 22% of shares in the VelocityShares Daily 2x VIX note are in the hands of shorts, up from 4% a week earlier. The bets may reflect the view that the product, which gains when futures on the VIX rise, will decrease in value, though these trades could also be part of a hedging strategy.

A more retail-friendly way of shorting volatility is also getting traction. The biggest exchange-traded product betting against price swings has taken in nearly $134 million in the last two sessions, its biggest two-day haul since early 2018.

The ProShares Short VIX Short-Term Futures ETF, which delivers one-half the inverse of a blend of futures on the gauge, is an imperfect way to short vol because the contracts typically trade at different levels from spot.

Yet it's a popular tool among the mom and pop crowd -- who used to pile into the more high-octane XIV before the note blew up in 2018.

To contact the reporter on this story: Yakob Peterseil in London at ypeterseil@bloomberg.net

To contact the editors responsible for this story: Sam Potter at spotter33@bloomberg.net, Sid Verma

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