By the end of the third quarter, when VIX was constantly updating record lows, it became known that the Vega (measure of the sensitivity of options to the volatility of the underlying asset) in the sphere of inverse VIX ETPs using financial derivatives and debt to raise the base index profit reached $ 375 million – a record high level.
As Bank of America notes, this was the result of the highest positioning of long VIX ETPs using financial derivatives and debt obligations since July 2016, which was offset by a record high impact of short ETPs.
And although the burst of long volatility ETFs vega – this is what was fixed from 2016, compensation with inverse VIX ETP, of course, was something new.
Analyst Goldman Rocky Fishman emphasizes that, as part of the acceleration movement that we observed 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 the strategist Goldman wonder about whether or not to worry.
The reason for Fishman’s concern is that the recent growth of AUM in inverse VIX ETP has raised fears that investors investing in these products will strengthen VIX and VIX futures, provoked by fundamental factors.
Analyst Goldman notes that while some may consider this to be an excessive risk, he “is most concerned about the flows of inverse ETFs and ETFs using financial derivatives and debt to raise the base index return that will be caused by the growth of futures on VIX.”
As explained by Fishman, the reason for this is that “the transition to a pure negative vege occurred for passive reasons: high performance of shares (XIV to 185% in 2017) raised each share by XIV and SVXY by 50% more than VIX, as it was three months ago, compensating for the net outflow of products. ”
This was even more reflected in the negative vege, because, as Goldman estimated, the short VIX ETPs actually showed a net outflow in 2017, despite their high profitability, as investors profit from the rise in stock prices. Meanwhile, “long VTP ETPs showed an influx.”
Another surprising observation: “Although ETI-related VIX activity continues to dominate the use of futures on VIX, CFTC reports show that hedge funds now have a short position on futures on VIX, which is not explained by the positioning of VIX ETP.”
In short, retail investors and hedge funds now have a net short volatility, which is reflected in the table below. What does it mean?
First, recall Marco Kolanovich’s warning from JPM in June last year that there is now a risk of “catastrophic losses” against the background of various sales strategies if VIX moves only 5 points from 10 to 15: “For a number of strategies, this will happen , if VIX grows from about 10 to only 20.
Although historically there has never been such an increase, this time one can expect a sudden increase in this value.In one scenario, one can expect VIX growth from ~ 10 to ~ 15, and then a liquidity crash. ”
This is the same conclusion that Fishman made today, but instead of moving by 5 points, he expects VIX to move just 3 points. Only the growth of VIX by 3 points will make $ 110 million to buy a vega. This is due to Fishman’s original question about whether it’s worth worrying, because it will be twice as high as before 2017 and “amount to about 60% of the daily volume of VIX futures.”
Such alarming conclusions are unlikely to be a surprise to anyone. According to Fishman, the biggest concern “is the one-day surge in volatility by the end of the day”: “The rebalancing of the VIX ETP will be most effective in the event of a quick sale of SPX by the end of the trading day.
With rebalancing, primarily through inverse products, a multi-day surge in volatility will be less effective. ”
If all this sounds familiar, it is only because Fishman paraphrased a similar observation made by Barclays several months ago that the main risk is the scenario of “one or two strikes” will unfold in two stages. ”
At the first stage, the VIX will grow slightly and then stabilize for several days at a high level. However, if at that time the fundamental factors of the bu It will create an air-hole phenomenon, in which the subsequent take-off of VIX will intensify.
Conclusion Barclays back in September was alarming: “The overall demand from VIX ETP managers is likely to be higher compared to the situation a few weeks earlier and is a significant source of risk. The only caveat that can be made is that the volume of futures on VIX , is likely to overcome the $ 1 billion mark during the shock scenario. ”
Since Goldman shows, the total demand for the purchase of VIX in the event of a market shock has only skyrocketed, as the vega has reached historical lows and is now effectively tied to the highest level.
But the most terrible thing is that the longer the current situation persists, the more negative the vega will be.
That’s why Eric Peters of One River “relies on the whole volatility explosion”: “Given that volatility has fallen, investors are forced to sell even more to ensure sufficient profit.” This sale increases the downward trend, which creates the illusion that today it is less risky than yesterday, so low volatility generates even lower volatility.The growth of volatility generates more volatility and, given the unprecedented volatility in this cycle, the market is historically changing m on the way to the normalization of policy. What is now started. ”
Until now, this loop feedback constantly declining volatility, proposed by Peters, 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?
And although no one can confidently give any answer, we will soon find a number of potential reference points that will finally take the market from its current state, which Fasanara Capital defines as the “edge of chaos”, and lead him to his next, much more volatile phase.
