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VIX in Backwardation: Volatility ETFs In Focus

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For volatility-based products as the market continuously hit highs on Trump trade. While the passing of tax reform and hopes of materialization of many more pro-growth policies triggered the stock market rally, earnings improvement and synchronized global growth led to broad-based gains.  

The long streak of gains for the key U.S. indices wavered to start February 2018 as stocks slipped into the correction territory on overvaluation concerns as well as rising rate worries and higher inflation expectations.Needless to say, volatility or the fear gauge indexwent up in recent sessions withiPath S&P 500 VIX Short-Term Futures ETN (VXX - Free Report) gaining 85.6% so far this year (as of Feb 9, 2018) materially (read: 5 Long/Short ETFs to Play in Market Crash).

A Few Market Watchers Betting Big on Volatility  

Against the aforesaid backdrop, the world’s biggest hedge fund – Bridgewater Associates – cautioned that global markets are about to hit a new phase of volatility in the process of adjusting itself with higher interest rates.

The Fed has enacted several rate hikes since December 2015 and is likely to implement at least three this year. Given the economic pickup in the Euro zone, the ECB is also deemed to leave the QE-era soon. Other developed countries like Canada have also embarked on policy tightening.

As the broader market steadied from the latest selloffs, the largest Hedge Fund of the world sees a lot of contentment still remaining in the market and a “big shakeout” to come.

David Bassanese, the chief economist at BetaShares Capital in Sydney, noted that that “despite the big falls last week, the selling could continue.” He reasons out that the correction doesn’t go beyond 15% for the sort of bull market we have experienced. This suggests that some selloff is still due. Brian Levine, co-head of global equities trading at Goldman Sachs, also cautioned its clients that the market possibly is yet to hit the bottom.

VIX Futures Curve in Backwardation

Investors should note that these products are suitable only for short-term traders. This is because most of the time, the VIX futures market trades in a condition known as contango, a situation where near-term futures are cheaper than long-term futures contracts.

This is because “projections about the outlook for the S&P, like for the weather, normally become more uncertain the further into the future one looks,” which is why volatility in the longer horizon is normally higher.

But currently the entire VIX (The Cboe Volatility Index) futures curve is in backwardation meaning that investors expect more volatility in the near term. Shorter-term contracts for volatility are now costlier than longer-term ones, as per Bloomberg (see: all the Volatility ETFs here).



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