The stock market has been unusually calm this year, prompting traders to place increasingly large bets on low market volatility — but they could be setting themselves and the broader market up for big losses.
What's happening: The S&P 500 hasn't moved more than 1% in either direction in more than 5 weeks, according to Datatrek co-founder Nicholas Colas. That defies historical trends and is leading more investors to take short-sell bets that the Cboe Volatility Index (VIX), which tracks big, unexpected moves in the market, will decline.
- The latest CFTC data shows speculators' short bets against the VIX outnumber longs nearly 2.5 to 1.
Why it matters: The big losses triggered in short-volatility trading instruments helped lead to the stock market selloff in December that pushed the Dow and S&P 500 to their worst December since 1931.
- In February 2018 stock market volatility triggered losses so steep that both Credit Suisse and Nomura were forced to shutter their short-VIX products.
Threat level: With the Fed expected to cut interest rates this month and at least once more in 2019, central banks around the globe have initiated a cycle of easy monetary policy, increasing liquidity in capital markets.
- That's underpinning expectations of a low volatility that could easily unwind given the uncertainty of the U.S.-China trade war, weak earnings expectations, declining global growth and rising geopolitical tensions in the Middle East and Asia.
The big picture: Investors raised short volatility bets to the highest level in 6 years in April, according to analysts from Nordea Bank, who spoke to Refinitiv's IFR.
- June and July's unprecedented market calm have again whet investor appetite for the products in what has so far been a summer of very low volume trading.
- However, low trading volume can mean big trades move a market significantly, spiking volatility and triggering potentially massive losses.
What to watch: "It's a worrying sign," Andreas Steno Larsen, senior global strategist at Nordea told IFR.
- "The interest is definitely there broadly speaking across asset classes. I consider that a natural result of the U-turn we've gotten from central banks."
Yes, but: Larsen made the comments in April and the market has continued to rise — and VIX has continued to fall — since then.
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