As it stands today, the “Short Volatility Trade” has been watered down to a great extent. Perhaps in an effort to get ahead of the regulators, most of the Exchange Traded Products (ETPs) that deal with “short volatility” have made adjustments so that their products are no longer as volatile as they had previously been.
As trading opened on Monday, February 5th, 2018, stocks had already been falling for a few days. Then on that day there was a major decline – the largest drop in point terms in history. The Dow was down 1,175 points. The S&P 500 Index ($SPX) was down 113 points. All other major stock indices suffered similar fates. Those net changes were effective as of the 4 p.m. (Eastern time) close of the NYSE.
One of the most successful investment strategies practiced by hedge funds (and other sophisticated investors) in the last ten years has been the “volatility short” trade. It is rarely mentioned on TV or in the media, but that is not too surprising. They would rather promote things such as the “Japan carry trade,” which wasn’t necessarily a profitable strategy at all unless a great deal of risk was taken. Not to say that the “volatility short” didn’t have its own share of risk, but it’s a lot more certain to profit if a certain status quo is maintained.
In this article, we’ll look at the history of the “volatility short” trade and see where it stands today. The long-term perspective on this trade may be a bit surprising, for it shows the tremendous toll that the $VIX futures premium takes on a long volatility position.
