The "Protection Trade”: Will being long volatility and the market work?

By Lawrence G. McMillan

For quite some time now (perhaps since last November), we have been pointing out how the voracious appetite for volatility protection has had the effect of distorting the term structure of the $VIX futures.  Recently, though, this activity has branched out in a way that is only rarely seen in the markets: in short, large institutional traders are both buying stocks and buying volatility ETNs (thus, by inference, they are buying $VIX futures).  Hedging on a large scale can distort technical indicators and other things – such as the term structure.  That is, we can’t really interpret this activity in a contrary manner.  Are these traders bullish (because they’re buying stocks) or bearish (because they’re heavily buying protection)?  In truth, it’s probably the former, but their need to buy protection also means they’re not overly bullish.  This reminds me very much of what was happening in QQQ options at the end of the tech stock craze in 2000....

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