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Volatility Trading: The Market Tactic That鈥檚 Driving Stocks Haywire | WSJ - YouTube
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(dramatic music)
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- [Liz] Over the past few months,
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volatility has ruled the markets.
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Here's the S&P 500 on Thursday, June 11
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when the index fell 6% in
a single day of trading.
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It was a rough day.
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But not for everyone.
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This chart from the
same day shows the price
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of UVXY, a fund that's
tied to market volatility.
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You can see, as the S&P
tumbled, UVXY gained.
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This fund in a type of volatility trade,
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which is a kind of bet
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that has lately attracted
more investors and critics.
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Analysts say volatility
trading doesn't only benefit
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from market turbulence,
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it can actually make the swings bigger,
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which could make markers
riskier for everyone.
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We'll explain.
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To understand volatility trading,
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a good place to start is
the CBOE Volatility Index
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or the VIX.
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The VIX is known as
Wall Street's fear gauge
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and it basically measures
market volatility
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and it's based on options
prices tied to the S&P 500.
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- [Liz] The VIX tracks the price
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of calls and puts, which are contracts
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that allow investors to
bet on whether stocks
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will rise or fall.
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When a lot of investors
are expecting big swings,
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that demand can drive up the price
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of calls and puts.
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For example, on March
16, the VIX rose by 43%,
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a huge jump that led the
index to a record close.
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- So on March 16th, the market crashed.
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Stocks had one of the
worst days in history.
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Investors were reaching
for options contracts
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throughout the day, driving up the prices
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of those options contracts
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because they expected more
volatility in the future,
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and that drove the VIX up.
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- [Liz] Now, on that day,
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traders were not only betting
which way stocks would go,
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they were also betting on
which way the VIX would go.
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That's a type of volatility trade
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but there are others too.
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In fact, there's a whole
ecosystem of trading products
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that allow investors to bet on how rough
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or calm the markets will be.
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Experts say these bets
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and the hedging traders do to cover them
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could be affecting the
market in really big ways.
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- So volatility started out as a metric
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to measure the market
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but now we're seeing thee products
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that trade volatility and
the whole host of derivatives
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to trade volatility getting so big
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that some analysts say
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that they can actually
influence the market
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and drive more volatility.
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- [Liz] This current stretch
of market swings comes
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after a decade of increased interest
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in this type of trading.
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Here's a look at assets in hedge-funds
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that trade market turbulence
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and here are assets under management
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for exchange-traded
products tied to the VIX,
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like the UVXY.
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You can see, the volatility
business took off
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after the financial crisis
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and grew from there
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as bankers devised new and
risky ways to trade it.
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Both charts mark 2020 as a record high.
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- It's been a crazy few months
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for the stock market
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and we've seen some of the biggest swings
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we've ever seen in history
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and what that's done is actually
that's drawn more interest
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to these types of trades,
the volatility trades.
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That means people are putting more money
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in these exchange-traded products
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that bet on volatility.
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- [Liz] For some investors
and hedge-fund managers,
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the strategy has paid off.
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- One investor I spoke to,
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his strategy's up more
than 200% through May
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while the S&P 500 has
fallen over that timeframe.
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- [Liz] Remember UVXY?
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Here it is for the full year
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and this is the spoke we showed earlier.
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UVXY has had some big gains
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but not everyone has won.
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There have also been big downward moves,
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leaving some investors with huge losses.
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- We saw just this year
professional investors
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and professional hedge-funds
that trade volatility,
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some of them took some really big loses
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or shut down entirely.
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Look, these are really risky strategies
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and it's important for investors
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to proceed with a ton of caution
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because it's definitely
not a guaranteed win
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for you to bet on market volatility
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and even some of the most successful
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and sophisticated investors
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can have trouble with these trades
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because they can be really difficult
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to manage the risk associated
with derivatives trading.
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- [Liz] It's unclear how
long this current bout
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of market turbulence will last
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but experts agree on something.
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A more volatile market
is also a riskier one.
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(dramatic music)
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