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Is It Possible That Simply Trading Volatility Products Can Alter the VIX Itself?

Feb 12, 2018

Is It Possible That Simply Trading Volatility Products Can Alter the VIX Itself?

The notion of being able to trade volatility is still new to many investors though instruments for doing so have been around since the turn of the century. As bond-buying initiatives by central banks have worked to depress volatility in the equities market, however, ETPs based off the CBOE Volatility Index (VIX) have become increasingly popular. This topic is explored in a Financial Times article written by Joe Rennison and Robin Wigglesworth and titled “The Unstoppable Rise of Trading Market Volatility”. Not only are these products increasingly popular, they have become substantially profitable as well.

 

Traders who had the foresight to invest in the largest of the short VIX products, the VelocityShares Daily Inverse VIX Short Term ETN, known by its symbol XIV, would have realized a gain of 320 percent by holding it from the beginning of 2015 to the end of 2017 (they were short volatility as it dropped). Investors who were long the VIX from 2015 until the recent rise would have witnessed an 85 percent gain as the VIX grew rapidly (they benefitted from its recent spike).

Is it possible, however, that simply trading volatility products can alter the VIX itself? There has been an increasing concern amongst analysts that the trading of ETPs based around the VIX have fueled the growth of the VIX that is supposed to be their foundation. In fact, there has been a growing sentiment that the products established to make money from tracking the VIX are now influencing the underlying calculations that form the VIX. There exists the potential that this leads to a dangerous cycle in which it becomes possible for investors to manipulate the VIX index as it best suites them. This is an important notion to consider, especially as the practice of trading volatility becomes more tolerable.

To read the FT article please click here