By Saqib Iqbal Ahmed

NEW YORK (Reuters) - A sharp drop in U.S. stocks is provoking selling from volatility-sensitive funds, exacerbating a selloff that has already brought the Nasdaq Composite into correction territory.

Volatility control funds - systematic investment strategies that typically buy equities when markets are calm and sell when they grow turbulent - have gorged on stocks as indexes soared to record highs in 2024.

More recently, they have begun selling, as worries over the economy and tech earnings rattle investors: volatility control funds have dumped about $83.6 billion of U.S. equity futures over the last two weeks, according to Charlie McElligott, managing director Cross-Asset Strategy at Nomura.

It's "extremely rare" for the funds to sell in that size, McElligott said, noting that they have only recorded a sharper pullback in their equity allocations 3.2% of the time in the last 10 years.

The moves come on the backdrop of a selloff in U.S. stocks that deepened on Friday, after weaker than expected U.S. employment data spurred recession fears. The S&P 500 has slipped about 5% from its July 16 record high, while the tech-heavy Nasdaq Composite Index, has slipped about 10% from a record high reached last month, putting it on pace to confirm a correction.

The Cboe Volatility Index stands at its highest level in more than 16 months.

The funds’ behavior going forward depends on how volatile markets are in the next few weeks, McElligott said.

A 1% daily change in the S&P 500 over the next two weeks could spur another $15 billion of selling in that period, while daily 0.5% changes would stop the bleeding and see these funds turn buyers to the tune of about $14 billion, McElligott said.

Certain other slower-reacting volatility-sensitive strategies could also join the selling if the market selloff worsens.

Equities trend-following commodity trading advisers (CTAs) sold only about $12.5 billion over the last two weeks. But these systematic, rule-based investment strategies could ramp up selling to about $36.0 billion if the S&P 500 were to sell off another 4% over the next two weeks, McElligott said.

(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Nick Zieminski)