Raymond Nolte, managing partner at SkyBridge Capital, a fund of hedge funds, says he has never been a big fan of selling volatility. "It's like writing hurricane insurance because we haven't seen one for a while. If you want to sell premium you should do so when volatility is high, not near historic lows."
Mihir Worah, a deputy chief investment officer at Pimco, says the firm was selling ahead of this year's decline in volatility. "Obviously at these levels we are not selling volatility aggressively," he told the Financial Times.
Vol, as the traders call it, has effectively become an asset class unto itself, although trading it is more complicated than buying or selling stocks and bonds. It is more complicated, too, than buying and selling insurance as generally understood by anyone with a fire or flood or car insurance policy.
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Selling volatility typically involves selling options, which would pay out if a particular market moved by more than a pre-agreed amount. The Vix index, sometimes referred to as the stock market's "fear gauge," is based on the price of a combination of options on the S&P 500. The more investors are paying to protect themselves from big swings, the higher it goes. The fixed income market has a similar gauge called the Move index.
Both are close to historic lows, and traders are in the midst of a vigorous debate about why. The economic recovery and central bank support for markets suggest big swings may be unlikely. But some traders think vol may be priced too low for technical reasons, too, such as the retrenchment of bank trading desks and resulting illiquidity, or an imbalance between supply and demand.
According to Maneesh Deshpande, head of equity derivatives strategy at Barclays, the demand for protection from volatility has soared, but the supply from people selling insurance has soared even more.
"Premium has declined to the levels prevalent in the 2004-2006 period, so we call it the 'old normal' – but with a twist," Mr Deshpande said.