Traders are doubling down on one of the market's hottest trades

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You'd think last Thursday's stock market shock would have investors betting on more price swings.

The opposite has happened.

Traders are instead using the 44% single-day spike in the CBOE Volatility Index — or VIX — as a reason to pile into wagers that the measure will come back down.

Using exchange-traded notes, they've made their exposure $393 million more bearish on the VIX over the past week, according to data compiled by financial analytics firm S3 Partners. In other words, they're betting that stocks will revert back to the listless, sideways trading that's characterized so much of the action in 2017.

One place traders are looking is the VelocityShares Daily Inverse VIX Short-Term ETN, which amounts to a direct short bet on the fear gauge. It's surged a whopping 81% year-to-date, and investors have added roughly $165 million of exposure over the past week.

These traders are "looking for the VIX index to continue declining from its recent year-to-date high and settle back nearer its 10.79 July/August average," Ihor Dusaniwsky, managing director of predictive analytics at S3, wrote in a client note.

S3 Partners

It's just the latest sign of confidence in the short volatility trade, which has been one of the year's most popular and, by extension, crowded wagers. Investors have been rewarded recently by a VIX that hit a record low, but they've also been jostled by occasional turbulence. Clearly that isn't holding them back now.

The willingness of investors to add to short-volatility positions at more attractive prices — in this case, following a large price swing — mirrors a similar dynamic unfolding in the equity market. The so-called "buy the dip" phenomenon has been a hallmark of the eight-year bull market, helping sustain it as traders use weakness as an excuse to load up on more shares.

But just because traders are ramping up anti-volatility exposure doesn't mean everyone thinks it's a good idea. One of the most vocal opponents of the short-volatility trade has been JPMorgan quant guru Marko Kolanovic. He's wary of the ever-present possibility of an big, unexpected market move, which could result in a painful unwind.

The warnings sent by Kolanovic and other short-volatility skeptics have yet to come to full fruition, but their advice should be heeded. If the dip-buying habit in stocks ever starts to fade, the market could eventually face a selloff so deep that traders will wish they'd listened.

Markets Insider

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