This market structure is clearly something to be concerned about: Trader on reddit stock frenzy
The world’s largest volatility ETF topped US$2.5 billion in assets for the first time, prompting speculation that Reddit traders have turned their attention to betting on market turmoil.
The ProShares Ultra VIX Short-Term Futures ETF (ticker UVXY) has nearly doubled its assets this year amid a streak of inflows that included a record US$280 million in a single day.
Such growth in a “relatively obscure” exchange-traded fund has the likes of Michael Purves of Tallbacken Capital Advisors LLC pointing the finger at the newbie day traders shaking up Wall Street.
“Why the UVXY is growing exponentially likely has something to with its growing attention in social media platforms like Reddit/WSB,” Tallbacken’s CEO wrote in a recent note. He noted that the security has been the subject of postings on the WallStreetBets forum, and that some members of the online community have been focused on an equity sell-off.
There are more signs of the day-trading crowd: Call-option open interest is surging on both UVXY and its cousin, the iPath Series B S&P 500 VIX Short-Term Futures product (VXX). These derivatives are a favorite of the retail-investing cohort, which has become famous in the past month for pushing around everything from heavily shorted small caps to silver.
“It seems plausible that this ETF -- the only significant long VIX ETF with leverage -- is simply being viewed by retail as a smart way to hedge out a market crash,” wrote Purves. “The leverage provides, in theory, the returns that feel like a squeeze on a heavily shorted small cap stock.”
While some investors may be drawn to the fact that UVXY hit an all-time low this month, it’s historically expensive right now to hold a leveraged long-volatility product. UVXY and VXX track a mixture of first- and second-month futures contracts on the Cboe Volatility Index, which are trading at huge premiums to the fear gauge itself.
Absent a considerable volatility spike, those contracts will mechanistically lose value as time passes -- a decline known as the “rolldown.”
Positioning in volatility instruments can also be tricky to pinpoint, and there are theories that the inflows and options activity actually represent bets on volatility to fall.
When demand is high to wager against UVXY or VXX, market makers can create new shares to lend out to short sellers, which show up as inflows. Also, open interest in call options could mean that investors are selling call contracts instead of buying them -- a way of betting on continued calm.
“It’s important to keep in mind, surging shares outstanding and call open interest does not necessarily mean every investor involved believes volatility will spike,” Chris Murphy of Susquehanna International Group wrote in a note.
When Reddit traders piled into shares like GameStop Inc., part of the aim was to trigger a “gamma squeeze.” Retail investors bought call options on the video game retailer, forcing dealers to buy the underlying equities to hedge their own exposure -- thereby pouring fuel on the rally.
But ETFs are different from stocks in that market makers can create new shares in the products, breaking the feedback loop necessary for a gamma squeeze, according to Stuart Barton, portfolio manager at Invest In Vol.
“On the other hand, if UVXY got too big and the issuer halted creations, delevered, or closed, then things get funky,” Barton wrote on Twitter.