While a lot of interesting individual stock stories have come and gone this week–Yum! Brands (YUM) has lost its Chinese boost, Wells Fargo (WFC) has record earnings, and JP Morgan (JPM) is lowering its compensation–even the most fundamentals-based investor cannot help but be fixated on the macro. Macro funds, on the other hand, have had an opportunity to make a lot of money in a short period of time — and the risk of losing even more – -as volatility rode a steep roller coaster.
To look at the VIX for this week is to look at the market’s annoyance and frustration at D.C. in general and Congress more specifically. The catastrophic fallout of a U.S. debt default is too profound to consider, as the world economy depends on the U.S. dollar and the full credit of the USA, for better or worse. So it’s no surprise that another flirtation with a debt default, as we saw in 2011, would cause stocks to tumble. While this meant some declines in the S&P 500, the fallout has been relatively minor for the past week.
The impact on the debt ceiling woes has been felt in volatility, which is closely but not completely correlated with the S&P 500’s price gains and declines. For our purposes, we’ll focus on the VXX, even if this is an imperfect track for volatility itself. Still, the trend line is clear: a steep rise at the beginning of the week, following a steep decline. Last week, VXX was trading in the high 13s, and by the middle of the week as Democrats and Republicans played dueling press conferences. At the same time, hedge fund and value investor commentary ranging from the hyperbolic to the outright obscene, causing capital outflows from equities.
The VXX ETN spiked over 17.30 and saw a sudden drop as lawmakers announced a tentative short-term deal may have been reached. Relief caused a bit of a rise in the S&P 500, but that’s nothing compared to the correlating decline in VXX, which fell 16.8 from its highest point in the span of two days.
This is, of course, a tremendous money-making opportunity. For macro investors confident that the U.S. would not default and the political stalemate would end sooner rather than later, shorting the VIX by selling short the VXX fund was a great way to make a strong profit in a short period of time.
Not that this was risk-free. Just as markets can remain irrational longer than you or I can stay solvent, politicians can too. If the stalemate had continued, VXX would not have fallen yesterday and today as it has, and would only have gone up more and more. A macro fund could still profit from this by growing exposure and waiting, but it’d be a nerve-wracking ride to say the least. And if too much capital was allocated to the bet, a margin call or short squeeze would result before the big payoff could be possible.
Again, the lesson to be learned in all of this is that there are many ways to make money, but more ways to lose money. Playing the VIX short-term from a macro thesis is a fine way to make money, provided that you have planned the trade well. If you’ve allocated sufficient capital to hedging the bet and you are willing to take a loss if necessary, then it could’ve been a great play. If, however, you want to gamble with an all-or-nothing bet, the ending would be much more tragic.