Traders have gotten killed using the Chicago Board Options Exchange Volatility Index (VIX) as a guide for future market direction lately. Bears who thought a spiking VIX signalled imminent market reversal back in early July ended up flattened by a 14% S&P 500 freight-train. You missed that, and you’ve missed a lot this year.
The VIX is looking like a broken indicator, and one reason could be that it’s becoming more a gauge of the “dumb money”, rather than the smart.
Barron’s: Since the steady premium in VIX futures and heavy demand for upside options bets on VIX have not yet been “obeyed” by the market in the form of a volatility spike, it has raised the possibility that these markets are now driven by “less-smart” money.
The number of outstanding contracts in VIX options has about doubled in the past year, with a heavy tilt toward bets on higher volatility. And an exchange-traded note, iPath S&P 500 VIX Short-Term Futures ETN (ticker: VXX), which allows for easy bets on a higher VIX, last month was flooded by new money. Its inflows as a percentage of assets were among the highest of all ETFs.
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