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Commentary: February's "volmageddon" good for banks, brutal for hedge funds

LONDON (Reuters) - The explosion in financial market volatility in February raised the question these episodes always throw up: was it “good” vol or “bad” vol?

A trader works on the floor at the New York Stock Exchange (NYSE) in Manhattan, New York City, U.S., March 2, 2018. REUTERS/Andrew Kelly

For the big market-making banks on The Street, it looks like it was good volatility. They raked in higher revenues from the resulting surge in trading and hedging activity from their clients, particularly hedge funds.

Industry sources say top banks saw equity trading revenues jump by around 15 percent following the volatility breakout in the first week of last month, as equity derivatives trading boomed.

Senior traders at one U.S. bank said February was the best month in a decade for equity trading, according to one source. Overall, big banks’ equity revenues are up around 15 to 20 percent so far this year.

This shows that it’s not the direction markets take that matters for big banks, but the volume of trading business generated. After all, trillions of dollars were wiped off the value of world stocks early in February and the S&P 500 fell 4 percent, its worst month in over two years.

The same can’t be said for hedge funds. Early indications are February was, for many hedge funds and speculators, a dreadful month, and for some strategies the worst on record.

This is counterintuitive. Hedge funds, particularly those in the macro space using trend-following strategies, have had a dismal couple of years because historically low volatility has made it difficult for them to exploit arbitrage opportunities and generate high returns.

They’ve been crying out for volatility. Yet it turns out what happened in the first week of February wasn’t the volatility they were looking for.

Eurekahedge’s main hedge fund index is on course to have slumped 2.01 percent in February, according to estimates from the industry index compiler. That would be its worst month since September 2011, wiping out all the gains accrued in January.

Some strategies did particularly badly. The CTA/Managed Futures hedge fund index crashed 6.18 percent, its worst month since Eurekahedge first compiled the index in 1999. The trend-following index plunged 8.39 percent, also its worst month on record.

These funds were wrong-footed by the surge in U.S. stock market volatility in early February when U.S. inflation fears gripped markets and traders suddenly began to price in higher U.S. interest rates.

Eurekahedge estimated that its CBOE short volatility index collapsed 16.72 percent, its worst month on record, while the long volatility index rose 1.92 percent, its best month since January 2016.

The latest positioning data from the Commodity Futures Trading Commission show that the shakeout in hedge funds’ and speculators’ bets in major equity and fixed-income markets in February was also, in some cases, without precedent.

Speculators cut their net short two-year Treasuries futures holdings to 104,947 contracts in the week to Feb. 27. That meant the monthly change from the record net short position at the end of January was an unprecedented 224,119 contracts.

They trimmed their long VIX volatility futures positions for the third week in a row, by 25,167 contracts in the week to Feb. 27. But the increase in net long VIX futures positions over the course of the month was a record 93,740 contracts.

It looks like February’s “volmageddon” was good vol for banks and bad vol for hedge funds. And if U.S. regulators are to get their way, the lines between bank and hedge fund may be blurred further as certain post-crisis banking regulations are rolled back.

According to several regulatory and industry sources, U.S. authorities are considering changes to the “Volcker rule” that will give Wall Street banks more leeway in trading and investing.

The rule forced many Wall Street banks, which before the crisis could gamble on their own account across various assets, to overhaul their trading operations and hive off billions of dollars’ worth of investment vehicles.

The rule aimed to prevent banks like Goldman Sachs and JPMorgan Chase from making risky market bets. Yet banks and some of their customers say it is too much of a burden for the financial industry by limiting banks’ ability to facilitate investments and hedges for investors and depressing trading volumes in some assets.

The opinions expressed here are those of the author, a columnist for Reuters.

About the Author

Reporting by Jamie McGeever; Editing by Larry King

The views expressed in this article are not those of Reuters News.