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