Traders Shorting VIX Spur Inflows to $1.2 Billion Fund Down 34%

(Bloomberg) -- The world’s largest volatility ETF is seeing a frenzy of activity as traders across Wall Street bet on enduring calm in the stock market.

Even as the ProShares Ultra VIX Short-Term Futures exchange-traded fund (UVXY) -- which protects against swings in U.S. equities -- slumps 34% in the election aftermath, it’s on pace for the biggest monthly inflow since July.

The unlikely state of affairs may be explained by surging options activity and a rising number of shares out on loan in the $1.2 billion product. That points to investors betting against it on expectations the Cboe Volatility Index will keep falling into year-end.

“The fact that these inflows are happening after the election suggests that short sellers are looking for shares to borrow,” said Vance Harwood of Six Figure Investing in Colorado.

The theory is that the inflows -- $320 million in November so far -- are connected to what’s known as “create-to-lend.” Institutions can create new ETF shares directly with the issuer and lend them out to short-sellers for a fee, and those creations show up as inflows to the fund.

The number of UVXY shares sold short rose to 1.3 million on Friday from around a million at the start of the month, according to IHS Markit data.

For institutions hedging themselves with VIX futures or swaps, it can be “a strategy that’s essentially risk free and yields a lot more than Treasuries,” said Harwood.

Traders are betting on turbulence to subside across the volatility complex after fearful investors bid up the price of stock hedges to record levels before the election. VIX puts have been one way to wager on the fear gauge falling, with the number of bearish contracts surging recently.

Meanwhile, options activity on UVXY also seems to support the short-volatility argument. Open interest in the fund has climbed to 838,000 contracts, the highest level since March.

“UVXY is very popular among smart option traders,” said Jim Carroll, a portfolio manager at Toroso Advisors. The inflows into the ETF may represent hedging activity from these traders or Wall Street dealers, he said.

The largest open interest is in UVXY puts that expire in January with strikes between $11 and $14 a share. Those contracts will increase in value the lower UVXY falls from Monday’s closing price of $12.60.

Fund flows are notoriously difficult to untangle, however. The fingerprints of volatility sellers may be all over the counter-intuitive inflows, but Harwood acknowledges there could be a contingent of investors expecting turmoil to resume. Covid-19 is still raging and the election is not fully settled, after all.

“Since UVXY is the only leveraged long volatility fund now, I expect it will be popular for both shorting and tail risk protection buying,” said Harwood.

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