A Three-Year High In VIX Bets Puts Volatility  ETFs On The Radar

Demand for call options based on the Cboe Volatility Index is skyrocketing, suggesting that traders are bracing themselves for an increase in US equities volatility.

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Call option trading volumes on an average daily basis in February increased to levels that were not seen since the Covid-related share price meltdown in March 2020, according to the Cboe Volatility Index, popularly known as the VIX.

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The VIX index tracks how much the market anticipates US large-cap shares will fluctuate over the next 30 days. The implied volatility in short-term S&P 500 option contracts serves as its source.

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In contrast, VIX derivatives are readily available volatility instruments based on the VIX that let investors control their exposure to volatility regardless of the direction of the stock market. Purchaser of VIX call options often want to protect themselves against potential stock market volatility because these options are profitable when the VIX climbs above the contract's specified strike price.

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At the market's close on Friday, March 3, the VIX index level was 18.49. Readings below 20 are often indicative of calm in the markets, while readings above 30 reflect a substantial degree of panic. The VIX is still trading comfortably within normal bounds.

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The VIX reached 30 on four different occasions in 2022, underscoring the relative turbulence of the year as convergent risks such as the ongoing conflict in Ukraine, persistently high inflation despite sharply higher interest rates, and the possibility resurgence of Covid in China kept investors on edge.

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The VIX has been trading in the low 20s since early November, indicating a significant decline in volatility expectations from October as the markets grew more confident that the Federal Reserve will end its tightening cycle without seriously harming the US economy.

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This optimism, according to the Trade Algo, has recently been tested by hotter-than-expected economic statistics, which raises the chance that the Fed would have to raise interest rates for longer in order to lower inflation. One of the most common wagers made by options traders in February, according to the Trade Algo, was that the VIX will rise to 40 in the near future, a level not seen since March 2020.

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ETPs for volatility

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Volatility-linked ETPs may be used by investors to bolster their portfolios if they anticipate a spike in volatility.

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After being shunned by the market for several years after one of the largest products, the VelocityShares Daily Inverse VIX Short-Term ETN (XIV US), practically imploded during the 'Volmageddon' spike in US equity market volatility in February 2018, volatility-linked ETPs made a comeback in the US in 2022.

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Last year saw the debut of volatility-linked ETFs from two different issuers: Volatility Shares and ConvexityShares.

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The Volatility Shares 2x Long VIX Futures ETF (UVIX US), which denotes a long-only portfolio of short-term VIX futures, was introduced in April 2022 and offers twice (+200%) the daily performances of the Long VIX Futures Index. The fund has assets of $160 million and has a management fee of 1.6 percent, while the prospectus for the ETF warns that total expenses could reach 2.7 percent.

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ConvexityShares Daily 1.5x SPIKES Futures ETF (SPKY US) and ConvexityShares 1x SPIKES Futures ETF (SPKX US) both made their debuts in August and offer regular (+100%) and gently amplified (+150%) exposure to the SPIKES Volatility Index, respectively. The $360 billion SPDR S&P 500 ETF's indicated projected 30-day volatility is measured by the SPIKES Index, which is equivalent to the VIX (SPY US). The expense ratios for SPKX and SPKY are 0.65% and 0.79%, respectively.

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One of the least expensive ways to get VIX exposure in Europe is through Amundi's €100m Lyxor S&P 500 VIX Futures Enhanced Roll (Lux) UCITS ETF (LVO NA). This is based on cost ratio. The fund follows the S&P 500 VIX Futures Enhanced Roll Index, a 2nd volatility index that, in order to improve cost effectiveness, dynamically rotates between short-term and mid-term VIX futures based on their respective implied volatility. Its cost ratio is 0.60 percent.

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In contrast, the $20 million WisdomTree S&P 500 VIX Short-Term Futures 2.25x Daily Leveraged ETP (VIXL LN) provides daily exposure to short-term VIX futures with a 225% leveraage. It has a 0.99% expense ratio.

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