NEW YORK: Wall Street’s plunge this week has brought scrutiny to complex niche products to trade on volatility that market experts believe were poorly structured and exacerbated swings in stocks.
Only days before markets began to go haywire, Barclays chief executive Jes Staley warned about the risky investments at the World Economic Forum in Davos.
Many investors were using the exchange-traded products to place bets that volatility would stay low or go down, a “very smart” wager during a period of persistently low volatility, Staley said.
“But if this thing turns, hold on to your hat,” he added.
That change took place on Monday as the Dow Jones Industrial Average was in the midst of a more than 1,000 point drop that included a violent 800-point dive in the blue-chip index over 10 minutes.
During that period, the CBOE Volatility Index, known as the “VIX” index, also shot higher.
That shift spelled instant losses for “short-vol” trading vehicles, including exchange traded products by Japanese bank Nomura and Credit Suisse that had predicted volatility would go down, known as a “short” investment.
Because the VIX is known unofficially as Wall Street’s “fear” index over possible bad future outcomes, a sudden surge likely contributed to the brutal losses in the equity markets.