Investors jump on Barclays' iPath VIX ETN as 'fear index,' market risk seen as likely to rise

By Emma Trincal

New York, Jan. 20 - As they trying to hedge against potential market downside, investors have been rushing to buy Barclays Bank plc' iPath S&P 500 VIX Short-Term Futures exchange-traded notes due Jan. 30, 2019 linked to the S&P 500 VIX Short-Term Futures Index Total Return.

On Tuesday, Barclays priced an additional $1.5 billion of the ETNs, according to a 424B3 filing with the Securities and Exchange Commission.

The company priced $250 million of the notes at inception on Jan. 29, 2009; $250 million more on June 29, 2009; $1 billion on July 21; another $1 billion on Nov. 2; and $1 billion more on Jan. 4. The total amount of notes priced is now $5 billion.

When launching the VIX ETN a year ago, Barclays innovated by linking for the first time a note with volatility, using the VIX index as the underlying, said a sellsider executive. "It was the first product linked to VIX, and there have not been any others as of now," he noted.

The S&P 500 VIX Short-Term Futures Index Total Return provides exposure to futures contracts on the CBOE Volatility index (the VIX), which reflects forward implied volatility of the S&P 500 index at various points along the volatility forward curve and is calculated based on the prices of put and call options on the S&P 500.

Most popular iPath

The S&P 500 VIX Short-Term Futures is Barclays' most popular iPath ETNs. It recorded its second month as the bank's most-traded iPath ETN, according to a trading strategy report for October filed with the SEC on Tuesday.

An average of 1,491,000 of the Short-Term Futures notes changed hands each day. The VIX ETN has an average daily trading volume of $64.8 million.

The ETNs knocked the iPath S&P GSCI Crude Oil Total Return index ETNs out of the top spot in September.

Hedging a crash

"It's a bet on volatility, and it makes sense right now. Volatility has gone down, and people are expecting it to increase. So it's a very interesting play," a New York sellsider said.

People buying the ETNs are long the VIX, the volatility gauge also known as the "fear index." The VIX usually moves in a direction opposite to the market.

When the market rallies, as it has been the case in the last year, the VIX goes down.

In just one year, the VIX has dropped to 18.66 from 56.65, down 67%.

On the other hand, the indicator surges when markets collapse, which is why it is used as a hedge against a market downturn.

"A lot of people are looking at the VIX, and there are not many products on which you can trade volatility," said a London sellsider. "Volatility has been decreasing last year because during a rally people are less nervous and more comfortable with valuations. When this trend reverts and the market trades down, volatility picks up. This is what the market is expecting right now."

Poor record

Meanwhile, people who decided to buy the ETNs last year did not place their bet at the best time, sources said.

For instance, investors who bought Barclays VIX ETNs on Jan. 29, 2009 when the product was first introduced would be down 73% on their investment if the notes were still held today.

Buy low, sell high

"Last year may not have been the best time to buy. But I don't think buying it now is foolish at all," said Brian Kelly, founder and chief executive officer of Kanundrum Capital, a private investment company and global strategy and investment research boutique for institutional investors in Rowayton, Conn. "I can certainly make the case to buy volatility right now. The VIX has collapsed over last year. Volatility is low. It's a good time to get in."

Hedge among others

Other sellsiders, while stressing that market risk can be hedged in a variety of ways, agreed that volatility is one of the most efficient hedging tools when it comes to equity.

"There are many ways to hedge against a market downside. In fixed-income, if you think that the equity rally and the recovery themes are overdone, you hedge yourself with a range accrual linked to Libor because the Fed is likely to keep rates longer and that's how clients play that. But in equity, people use volatility to hedge," said a rate-linked products structurer.

Fear looming

Certain recent events have tempered the expectations of a global economic recovery among investors, Kelly noted, bringing doubts and fear back into the market.

"There's an awful lot of uncertainty, so it makes sense to buy volatility right now," Kelly said.

"Uncertainty globally stems from the simple question: When central banks withdraw their stimulus policies, what will happen with the economies? China is already playing a big role in volatility as they are tightening their lending standards. Looking forward, investors are wondering by how much growth will be reduced in China.

"Moving on to Europe, uncertainty is also on the rise. The questions are: will the Eurozone break apart? Will Greece be able to finance its deficit?

"And in the U.S., people are wondering - what's going to happen with health care? That's an awful lot of uncertainty right now, and it's global."

Who buys it?

Several types of investors are likely to buy Barclays VIX ETNs, sources said.

Retail buyers may be particularly attracted to the notes as an alternative to more complex instruments, said the New York sellsider.

"It appeals to retail investors because access to volatility as an asset class is not easy for them. It's complicated to do it with options. This VIX ETN gives them a unique opportunity to play volatility," he said.

"Still I am a little bit surprised at the volume of these deals over the past couple of weeks. I presume they must have found interest among asset managers as well and that there is a strong interest coming from the institutional side."

Regarding the use of the ETNs in a portfolio, Kelly said that investors may simply buy the VIX ETNs as a hedge against a market correction. Others may use it for directional bets. From a single retail investor to a proprietary desk offsetting positions or playing volatility trading, there are "a million ways to play this," said Kelly.

"My guess is that the majority of those VIX ETN investors buy it as a hedge," he said. "Only a small number would use it for directional bets."

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