A legendary volatility pioneer says one of the market's hottest trades is like 'betting on the roulette'

Roulette gambling casinoWikimedia CommonsDan Galai, a pioneer of the VIX, likens shorting the stock market fear gauge to playing roulette.

One of the market’s hottest trades this year has involved betting on stocks to sit still.

The wager in question is shorting the CBOE Volatility Index, or VIX, and many investors are big fans. Following a recent short-term increase in the VIX, traders added almost $US400 million of exposure to the trade. One guy — a former manager at Target — says he’s made millions betting against the VIX.

But not everyone thinks shorting volatility is so great. Hedge fund managers across Wall Street have highlighted a lack of price swings as a harbinger of pain. JPMorgan’s global head of quantitative strategy, Marko Kolanovic, has gone as far as to compare the strategies that are suppressing price swings to the conditions leading up to the 1987 stock market crash.

Count Dan Galai, a professor emeritus at the Hebrew University of Jerusalem whose work on an early volatility index was a precursor to the VIX, among those who dislike the shorting of the popular instrument.

In an interview with Business Insider, Galai offered his thoughts on the stock market fear gauge, and had some choice words for volatility speculators.

Here’s what Galai had to say (emphasis ours):

“It’s as if you’re in a casino, and you have some stupid hot money and are trying to use it on some sort of roulette game.

There are thousands and thousands of people trading VIX options, which is really a substitute for going to Vegas and betting on the roulette. Whenever people are turning the marketplace into betting, I don’t see it positively. But that’s a fact of life. People like to bet, and not to invest wisely. They’re not using any sort of long-term investment strategies.

But the market always has its own dynamics, and the effect is marginal. I don’t think they change the market. Volatility is low, and it’s been low. If the market was expected to change abruptly, we’d see it in options prices.

Shorting volatility is a type of trend. If you remember, before the birth of the internet bubble, some predicted that the market would collapse, and they went short, short, short. And they lost money for three years, until eventually the market collapsed. But a lot of those people were out of the market because they didn’t have money anymore. Anything can happen.”

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