The decline in stocks is over - not according to hedge funds

Hedge funds are betting that the recent turbulence in U.S. stocks will persist—a reversal after wagering for more than two years that the equity market will remain calm.

Leveraged funds, a category that includes hedge funds, were net bullish on Cboe Volatility Index, or VIX, futures as of March 6, the latest Commodity Futures Trading Commission data show—marking the first time bullish wagers have outnumbered bearish ones on the contracts since February 2016.

The about-face by hedge funds and speculators comes after a rocky month for stocks, with the S&P 500 and Dow Jones Industrial Average entering correction territory in February as investors grew jittery about higher inflation and volatility bets gone wrong rippled through markets. Since then, market turmoil has receded, but one measure of stock volatility indicates that it remains above last year’s average level.

A bullish bet on VIX futures can be a bearish bet on stocks, because the two tend to move in opposite directions. Traders can tap the derivatives to make directional bets on volatility itself or use the contracts to hedge their portfolios.

Hedge funds aren’t always good at timing their volatility bets. Volatility hedge funds may have squandered a chance to shine last month. They posted lackluster returns despite a surge in market turbulence in February, according to a March 9 report from JPMorgan Chase & Co. That environment should give volatility hedge funds more opportunities to make bets on which way volatility will trend and capture profits.

Short volatility hedge funds, which bet against volatility, didn't perform well last month as market swings picked up, which is to be expected, but long volatility strategies also floundered, according to JPMorgan, which analyzed data from Eurekahedge.

Strategies used by volatility hedge funds vary. Some bet on volatility through VIX futures and options or through derivatives on single stocks and indexes. Others try to foresee and profit from the next crash in financial markets. Volatility strategies are supposed to be less correlated to other assets in a portfolio.

This suggests that these short volatility hedge funds were poorly prepared or protected for a reversal of the past year’s low volatility trend,” wrote the JPMorgan analysts.

Source: The Wall Street Journal

Jr Trader Alexander Kumanov

Original Post: Hedge Funds Bet on Volatility

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