Should You Follow the Reddit Crowd and Bet on Volatility?

Afraid of playing the Reddit-fueled "stonks" but want in on the action? Bet the VIX.
Gregory BergmanFeb 17,2021,17:21

The VIX, the ticker symbol of the CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options, is now rising after closing below 20 last week for the first time in almost a year. The 246 days above 20 was the second-longest streak above that level ever.

However, interest in trading the VIX has risen to epic proportions. Who is the culprit? Well, Reddit traders, of course.

The ProShares Ultra VIX Short-Term Futures ETF (UVXY), the world’s largest volatility ETF, topped $2.5 billion in assets for the first time. Reddit's stock trading forums responsible for temporarily lifted struggling stocks like GameStop and AMC to new ridiculous heights have turned their attention to the VIX, some experts say. The relatively recent streak of inflows the UVXY included a record $280 million in a single day, according to Bloomberg.

Michael Purves of Tallbacken Capital Advisors LLC thinks the recent jump in interest in this volatility ETF is the product of amateur retail, Reddit-driven traders. “Why the UVXY is growing exponentially likely has something to with its growing attention in social media platforms like Reddit/WSB,” Tallbacken’s CEO wrote in a recent note.

Chris Murphy of Susquehanna International Group also wrote in a note on the matter, as quoted by Bloomberg: “It’s important to keep in mind, surging shares outstanding and call open interest does not necessarily mean every investor involved believes volatility will spike."

So, does this mean that the recent spike in VIX ETFs is more a product of this semi-artificial speculative play, or is it a sign that a market correction is coming?

It can be one or the other or both. I say both.

Also, playing the VIX, either through the VXX or the UVXY, is still historically a cheap trade. The VXX is trading only a dollar higher than where it was on Jan. 3 2020, two months before it exploded in March on the spread of the virus. The UVXY is trading at even more enticing levels; at $9.96, it is trading at a dollar less than it was on Feb. 18 of last year. In addition to historical cheap prices during what is still an uncertain time, playing volatility has its benefits. As one of our contributors, Michael Markowski, has pointed out, there are two unique benefits to betting on volatility:

1)Since the VIX is an index, it and the VXX, UVYX shares which trade it are not stocks and thus cannot go to zero.

2) When the correction does occur the VIX has the potential to spike immediately to produce triple-digit gains.

So Which to Trade?

If you want to take a riskier route, play the UVYX, which takes a 1.5x leveraged position on the S&P 500 VIX Short-Term Futures Index. As a leveraged ETF, the gains are higher when the underlying VIX index rises, while the loses are amplified if the underlying index falls. If you want a safer play, trade the VXX which, even considering its recent rise, is a good bet on future volaility. Still around its lowest levels in a year, given the interest in trading the VIX --and the fears of a mrket correction--the VXX is a bet worth taking as a hedge against a correction. Plus, as Markowski says, at least it won't go to zero.

GameStop, on the other hand...