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 Heading into Thursday's potentially momentous decision on interest
rates from the Federal Open Market Committee, the Federal Reserve's
monetary policy-setting panel, speculative positions in CBOE VIX
index futures are the most net long on record.
To this crowd of hedge funds and other big speculators, it really
doesn't matter what the Fed does. Raising rates for the first time
since 2006 would almost certainly send waves through equity markets,
and not moving will keep the guessing game - and accompanying market
gyrations - alive for weeks to come.
"There is a general consensus in the market that the Fed meeting
will continue the volatility, and if they don’t do anything it may
sustain the volatility at least for six more weeks till their next
meeting," said J.J. Kinahan, chief strategist at TD Ameritrade in
Chicago.
The most recent weekly Commitments of Traders data from the
Commodity Futures Trading Commission shows speculative net long
positions in VIX futures stood at 37,925 contracts as of Sept. 13.
Not only is that a record high, it is more than two standard
deviations from the norm.
Since VIX futures, a forward-looking gauge of market risk, were
introduced in 2004, speculative positions have been skewed toward
lower volatility far more often than not. Long VIX futures positions
benefit from increased volatility and can be used to protect equity
portfolios.
Moreover, positioning in VIX futures has flipped like never before
over the last month as the Fed guessing game has been compounded by
worries over the health of China's economy and its wobbly stock
market.
In contrast to the latest positioning, speculators in early August
were net short by 64,445 contracts - a reversal of more than 100,000
in five weeks - highlighting the strong conviction of hedge funds
and other large speculators that market gyrations are far from over.
LONGEST VOL BOUT IN FOUR YEARS
Volatility arrived in earnest for U.S. stocks about four weeks ago
as investors got rattled by a free fall in Chinese stocks and a
series of unsuccessful measures by authorities there to stem the
sell off.
That helped push the Standard & Poor's 500 index into its first
formal correction in four years, and the U.S. benchmark remains more
than 7 percent off its record-high close set back in May.
Unlike the many fleeting instances of volatility spikes seen in the
last couple of years, the current run up has not been quick to
recede.
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On Tuesday the VIX, which measures the cost for protective downside
positions on the S&P, closed above 22 for the 17th consecutive day,
the longest it has lingered above that level in nearly four years.
The index was last down 1.7 points at 22.54 on Tuesday.
Given the duration of the current bout of volatility and shocks of
similar magnitude in 1998, 2010, and 2011, it is unlikely that calm
will return to markets very quickly, MKM Partners derivatives
strategist Jim Strugger said in a note.
Trading in the options market also points to caution as investors
protect their positions and look to replace expiring hedges.
"Do I want to hedge for the next Fed meeting, or do I want to hedge
for the end of year Fed meeting?" is a question some traders appear
to be asking, Kinahan said.
Another factor is that Friday is a "quadruple-witching" day, when
options on stocks and indexes, and index and single-stock futures
all expire together. The expiry of existing positions and the
opening of new positions, called rolling, could make for some heavy
trading later this week and add to market volatility.
With the Fed decision due at 2 p.m. Thursday, just hours before all
those positions expire, it could make for chaotic trading.
"Thursday afternoon has a potential to be really active because what
the Fed says in the meeting may spell out to people where they need
to hedge to," Kinahan said.
(Reporting by Saqib Iqbal Ahmed; Editing by Dan Burns and Alan
Crosby)
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