This Trade Has Returned 633% in 2020—but Buyer Beware
Stock-market volatility has made betting on the speed and severity of market moves a popular—and risky—venture
One of this year’s hottest trades is betting on stock volatility. It is also one of the riskiest.
Traders big and small have sought to profit from the market’s wild swings. They are doing so through derivatives and exchange-traded products that tend to profit when markets are shaky. Some of the investments promise heightened exposure to volatility and often gain in value when stocks fall and turbulence rises.
It is the latest iteration of a long-running obsession with trading volatility since the last financial crisis, when betting on the speed and severity of market moves started to take off among retail and institutional investors alike.
This month’s moves have been unrivaled in the stock market’s history, igniting even more interest in the trade. The S&P 500 has swung an average of 5.2% every day, the highest on record and surpassing moves during the financial crisis, according to Dow Jones Market Data.
The head-spinning stretch for markets includes the index’s fastest-ever drop from a record into a bear market—defined as a 20% fall from the peak. U.S. stocks logged their worst week since the financial crisis earlier this month, then proceeded last week to stage the biggest three-day rebound since the 1930s.
Many are expecting the gyrations to continue as investors better understand the depth of the downturn stemming from the coronavirus pandemic. In the coming week, investors will get fresh reads on manufacturing and consumer confidence. New data released Friday showed a measure of consumer sentiment dropped sharply in March.
The recent swings—and perhaps the fear of the unknown ahead—make volatility wagers more enticing.
Assets under management for one such product, the VelocityShares Daily 2x VIX Short-Term Exchange-Traded Note, which goes by the ticker TVIX, hit a record $6.1 billion on March 19, FactSet data going back to 2014 show. Similarly, assets in the iPath Series B S&P 500 VIX Short-Term Futures ETN, or VXX, hit at least a two-year high of $2.6 billion that day. This month, VXX has been among the most popular exchange-traded products in the entire U.S. stock market.
It is easy to see their allure. While stock markets around the world have plunged this year, volatility has soared to levels never seen. Through Friday, the products were up 633% and 235%, respectively, year to date.
The S&P 500, meanwhile, has fallen 21% over that period. Its sharp swings continued last week even as the index leapt 10% higher after a month of punishing declines.
Through this tumult, even traditionally safer investments like gold and government bonds have fallen at times alongside stocks.
As other assets have fallen, rising volatility has drawn investors who might not otherwise trade the products, says Greg Taylor, chief investment officer at Purpose Investments.
“When things start to calm down, the vol can move fast and come out of the market quicker than anything else,” Mr. Taylor said. “People trading the vol ETNs and ETFs right now, I think, have to be really careful because those gains can drop quite quickly,” he said.
The products are notoriously risky to bet on. In the past, critics have said the products can sow more havoc and create distortions in markets. Holding them can chip away at a portfolio’s returns and timing their moves to profit from big jumps in volatility can be tricky even for seasoned traders.
Among those drawn to the trade is Shweta Agrawal, a retail trader based in Dayton, Ohio. She initially was attracted to TVIX because it appeared to buck the trend of the rest of the market.
“It looked like it was going against the market. Everything was going down, and TVIX was going up,” Ms. Agrawal said.
But in an unusual move, TVIX recently has fallen even as U.S. stocks plunged. For example, the product fell 6% March 20 as the S&P 500 dropped 4.3%. Something similar happened Monday. As TVIX kept falling in value, Ms. Agrawal kept buying, sure that it would rebound.
Ms. Agrawal said she lost about $50,000 trading the volatility product, a sizable portion of her portfolio. “I should have cut my losses,” she said.
Credit Suisse Group AG states in disclosures for the TVIX product that its volatility products are meant for sophisticated investors and should be used for short-term trading. Buying and holding the product likely will lead to significant losses, and the long-term value of the product is “zero,” the firm says.
Joe Amaturo, a Warwick, N.Y.-based project manager, said he initially bought shares of TVIX earlier in the year as he grew wary of the epic run in U.S. stocks, which were trading at records. It had been a drag on his portfolio, until recently.
“I added more because we are going into a big downturn in our economic situation,” Mr. Amaturo said. “Panic is hitting the market.”