Betting Long On Volatility Is A Sucker's Game
Bob Lang | Sep 10, 2017 01:14AM ET
Traders have been trying to make a big score buying volatility when it is low and looking for the ultimate move to the upside, dreaming of a 2008/09 type move when volatility took off like a rocket ship into space. In 2008 the VIX hit unprecedented levels, well over 90 as it appeared the world was coming to an end. That bet failed, and currently the play on higher volatility since has mostly been a wrong way play, as big spikes in volatility have been short-lived. We saw a couple of these moves in August, and volatility sellers once again took advantage.
Those two spikes in August were two of the biggest percentage moves of all time in VIX, yet coming from such a low base (from 10 to 16 or so) didn't really take much effort from the volatility buyers.
Note, we are not talking about taking on some cheap protection just in case of a disastrous outcome (which is a good thing). We have been noting this to be a credible strategy for awhile, especially when options are cheap with a low VIX (volatility index). Those who load up long volatility have been hurt severely as the trend in volatility has clearly been down. Spikes in volatility have paid off, don't get me wrong - but the volatility chart has clearly been trending down. This long volatility trade has been a loser this year, mostly last year and quite frankly -- for several years, since the financial crisis ended.
While many have been skeptical of the Fed's tactics, they have helped buoy the markets and provided a put underneath. Skeptics believe the endgame is coming and with it comes a surge in volatility. So many out there want to catch the 'next market fall', because the noise level is high after a nine year bull run. In a bear's mind, the rally has been on far too long. However, we must respect the market action and sentiment, the core of which is volatility.
The VIX has shown some big moves upward on occasion but those have mostly been a couple of panic days. Anyone seduced by the 'dark side' of the market (bearish sentiment) might make a few dollars on a rise in volatility, but staying long has led to nothing but pain and anguish. If you've been a bull, it's not easy changing stripes in the middle of the game.
For those who can ride volatility lower there have been some deep rewards. There was an article recently about a guy who worked at Target and managed to make some 12 million dollars shorting volatility products (there are several ETNs to choose from), trading at his home. He was not an experienced floor trader. These trades were not complex nor sophisticated, rather one could have mimicked the trading style based on prior trends and patterns of volatility.
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And forget about the 'reasons', such as the results of the election. The short volatility trade has been live and winning for years, it's not something new from a year or so ago that just began. Taking the other side of the short volatility trade has been a loser by far. But will it always be that way? Of course not, but our job is not to determine the end of a trend, rather just to ride it out until it is finished (or close to it) without getting hurt too badly when it turns.
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