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Wall Street Sours on Cboe After Collapse of VIX-Linked Funds

(Bloomberg) -- The pain continues for Cboe Global Markets Inc.

The exchange fell as much as 5.1 percent Wednesday, building on Tuesday’s record 10 percent plunge, after analysts at Goldman Sachs Group Inc. and JPMorgan Chase & Co. downgraded the stock to “neutral,” leaving just two buy recommendations on Wall Street.

It’s an abrupt shift for Cboe, which rallied 69 percent last year, more than any other financial stock in the S&P 500 Index. The Chicago-based exchange gave Wall Street something, an index called the VIX, that became the basis for a popular strategy: shorting volatility.

But that trade blew up this week. Funds that fall when the VIX surges lost billions of dollars this week when the index posted a record rally. Credit Suisse Group AG decided to liquidate one: the VelocityShares Daily Inverse VIX Short-Term ETN, which used Cboe’s VIX futures contracts to make its wagers. This is “potentially the tip of the iceberg with a likely reduction in VIX futures trading activity looking out 1-2 months,” JPMorgan analyst Kenneth Worthington wrote in a report.

Volatility Inc.: Inside Wall Street’s $8 Billion Time Bomb

Cboe executives defended the VIX in a conference call with analysts Wednesday afternoon. Some products, like the $1.7 billion IPath S&P 500 VIX Short-Term Futures ETN, surged this week as markets were battered. It jumped 33 percent on Monday and has gained more than 50 percent since last Thursday’s close.

“Those that had long exposure to vol had a heckuva four days,” Cboe Chief Executive Officer Ed Tilly said. Profits like those are good marketing for Cboe’s sales pitch that volatility is an asset class that can help insure portfolios, he said. “There are some amazing stories out there on hedged portfolios and how they performed in contrast to those that were not, or even retail investors who decided to take a position in a long vol” fund, he added. “It’s been an incredible opportunity for those who’ve listened over the years on the benefits of all these contracts.”

The CEO expects investors will continue to short volatility, too, even though many investors got burned. Now that the Credit Suisse fund is going away, traders will simply look for other ways to make that bet, including other funds or the VIX contracts Cboe offers, he said.

About 16 percent of VIX futures volumes in 2017 are traceable to the fund that Credit Suisse is closing and another one, the ProShares Short VIX Short-Term Futures ETF, according to a note from Barclays Plc analyst Jeremy Campbell. The ProShares fund has lost almost 90 percent of its value this week.

Increased regulatory scrutiny of VIX products could develop, which “has the potential to negatively impact the growth profile of the overall asset class,” Jefferies analyst Daniel Fannon wrote in a report.

Read More: Amateur Investors Get Burned on Wall Street’s Hottest VIX Trades

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