Volatility in a 130/30 Era

Kudos to Adam at Daily Options Report for highlighting a Barron’s article by Dennis Davitt of Credit Suisse in which Davitt makes some interesting predictions about volatility going forward.

Speaking about one of my favorite subjects, VIX macro cycles, Davitt predicts that the key factor in the next few years will be the influx of money from 130/30 funds that will create significant new demand for options products:

“In the past, when the market made new highs, the VIX trended lower. Today, the S&P 500 is up 6.5% on the year and the VIX is up 80%, and the newest user hasn't even shown up to the party yet. That user is the 130/30 money (a type of leveraged long-short investment strategy), which now stands at $100 billion and is projected to grow to $1.5 to $2 trillion over the next three years. With these new entrants using derivatives to hedge their portfolios, option-buying is sure to take a jump.”

Adam’s commentary on the subject closely approximates my own thinking (I’m glad he gets up three hours earlier to figure all this options and volatility stuff for me…):

“I think an underlying theme of all this is that different eras have different characteristics, and it's important to look at volatility within it's own context. In other words, a 15 VIX was actually fat a couple years ago, the market itself had trouble trading at double digit volatility. Today 15 might be as low as it gets.”

Not only do I agree with Adam here, but I think it is important to note that if the projections about new 130/30 money are on target, this could be one of the biggest stories of the next few years.