By the end of the third quarter, when VIX was constantly updating record lows, it became known that the Vega – a measure of the sensitivity of options to the volatility of the underlying asset – in the area of inverse VIX ETPs, using financial derivatives and debt instruments to increase the yield of the underlying index, reached $ 375 million – a record high level.
According to Bank of America, this was the result of the highest positioning of long VIX ETPs using financial derivatives and debt instruments since July 2016, which was offset by a record high level of exposure to short ETPs.
Although the surge in the long-term volatility of Vega ETFs is something that has been recorded since 2016, compensation using inverse VIX ETPs has certainly turned out to be something new.
Goldman analyst Rocky Fishman stresses that as part of the acceleration we saw in September, the net position of VIX ETPs has become short in the last few weeks, the second time in eight years. ”
This strange discovery made Goldman a strategist wonder whether to worry.
Fishman's concern is that the recent AUM growth in inverse VIX ETPs has raised concerns that investors investing in these products will strengthen VIX movements and VIX futures triggered by fundamental factors.
A Goldman analyst notes that while some may find this an excessive risk, he is “most concerned about the flows of inverse ETFs and ETFs that use financial derivatives and debt to increase the underlying index return that will be triggered by rising futures on the VIX.”
As Fishman explains, the reason for this is that “the transition to pure negative veg occurred due to passive reasons: high share performance (XIV to 185% in 2017) raised each share by XIV and SVXY 50% more than VIX as there were three months ago, offsetting the net outflow of products. "
This one was even more reflected in the negative vega because, according to Goldman, the short VIX ETP actually showed a net outflow in 2017, despite their high profitability, as investors made a profit from rising stock prices.
Meanwhile, "long VTP ETPs showed an influx."
Another astonishing remark: “although VIX activity related to ETP continues to dominate the use of VIX futures, CFTC reports show that hedge funds now have a short position on VIX futures, which is not explained by VIX ETP positioning.”
In short, retail investors and hedge funds now have net short volatility. What does it mean?
Remember the warning from Marko Kolanovich from JPM in June last year that there is now a risk of “catastrophic losses” against the background of various sales strategies if VIX advances by only 5 points, from 10 to 15: “For a number of strategies this will happen if VIX grows from about 10 to just 20.
Although historically there has never been such an increase, this time we can expect a sudden increase in this value. According to one of the scenarios, VIX can be expected to grow from ~ 10 to ~ 15, and then a liquidity crash. ”
This is the same conclusion that Fishman made today, but instead of a 5-point move, he expects a VIX movement of only 3 points. Only a 3-point increase in VIX will force you to spend $ 110 million to buy vega.
This is due to Fishman's original question about whether to worry, because it will be twice as many indicators until 2017, and "will be about 60% of the daily volume of futures on the VIX."
Such disturbing conclusions are unlikely to come as a surprise to anyone. According to Fishman, the biggest concern is “a one-day surge in volatility by the end of the day”: “VIX ETP rebalancing will be most effective if SPX quickly sells out by the end of the trading day.
With rebalancing primarily due to inverse products, a multi-day surge in volatility will be less effective. ”
If all this sounds familiar, it is only because Fishman rephrased a similar observation made by Barclays a few months ago that the main risk is that the “one-two-shot scenario” will unfold in two stages. ”
At the first stage, the VIX grows slightly, and then stabilizes for several days at a high level. However, if fundamental factors deteriorate at this point, this will create an air hole phenomenon that will increase the subsequent VIX take-off. ”
Barclays's conclusion back in September was alarming: “The overall demand from VIX ETP managers is likely to be higher than the situation a few weeks earlier and is a significant source of risk. The only caveat you can make is that the volume of VIX futures is likely to break the $ 1 billion mark during the shock scenario. ”
Since then, as Goldman shows, the general demand for VIX in the event of a market shock has only soared, as Vega has reached historical lows and is now effectively tied to the highest level.
But the worst thing is that the longer the current situation persists, the greater will be the negative vega.
That’s why Eric Peters from One River "relies on all volatility explosion":" Given that volatility has decreased, investors are forced to sell even more in order to provide sufficient profit.
This sale reinforces the downward trend, which creates the illusion that today it is less risky than yesterday. Thus, low volatility generates even lower volatility.
An increase in volatility generates even greater volatility. And, given the unprecedented volatility in this cycle, the market is undergoing historically changes towards normalizing politics. What has now begun. ”
So far, this feedback loop of constantly decreasing volatility, proposed by Peters, has worked without failures.
There is only one question left: what became the catalyst that changed this and provoked the growth of VIX and the fall of the market in the feedback loop?
Although no one can give any answer with confidence, we will soon find a number of potential reference points that will finally lead the market away from its current state, which Fasanara Capital defines as the “edge of chaos” and lead it to its next, much more unstable one. phase.