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A quick thing on the long-awaited, entirely predictable ‘Volpocalypse’

A quick thing on the long-awaited, entirely predictable ‘Volpocalypse’

How many warnings did buyers of XIV, the volatility-linked exchange-traded note (ETN) note that went bust last week get? A lot.

First there was the prospectus itself, which spelled out wipe-out risk fairly clearly. Then, there were multiple articles from multiple financial news and analysis outlets, myself included.

There were also tweets!

Like, lots of them!

This tweet was from Jan. 31st — about five days before the actual blow-up! The only response I got to this at the time was from a guy complaining that he couldn’t see the x-axis so the chart was meaningless. That wasn’t the point! And if you don’t understand what a change in the shape of the VIX futures curve might mean for volatility-linked products, you probably shouldn’t be trading them!

I tried to some up just how telegraphed this was in a short note for our markets morning newsletter, which you can sign up for (for free) here.

I don’t mean this to sound callous to those who lost their shirts on this product, but neither do I want this to be spun as a failure on the part of forecasters and journalists etc. This was a well-telegraphed event that people saw a mile coming. That doesn’t mean there wasn’t failure somewhere. The fact that some retail investors seem to have been taken completely by surprise in the recent turn of events suggests they probably shouldn’t have been in these products in the first place. Whether that’s a failure on the part of the regulator, the ETN-issuer, the brokerages that enabled trading in the products, or some other party, I leave that to others to decide.

It’s not just about the VIX

It’s not just about the VIX

There’s so much talk about volatility right now — and specifically the stubbornly low behaviour of the VIX  — that I thought I’d do a round-up of some of my previous pieces on it.

Please note, I’m in an anti-paragraph, anti-proofreading kind of mood today. So typos and big blocks of text are ahead.

1. On the VIX 

Let’s start with this one, from September 2013, about a new index trying to challenge the VIX, the index that most people associate with ‘volatility.’ For more than two decades, the VIX index run by the Chicago Board Options Exchange has been the financial industry’s go-to method for measuring expectations of volatility in the wider marketplace, with the CBOE turning the index into something of a cash cow thanks to the launch of futures tied to the gauge. VIX-related futures have in turn allowed a plethora of VIX-based exchange-traded products (ETPs) to also launch. With all that money benchmarked to the VIX, it’s no surprise that we have occasionally seen upstarts attempt to challenge it.

2. Selling volatility

Now let’s go here to this story from December 2014. About six years on from the financial crisis and deep in the era of monetary stimulus, investors are struggling to make returns and seize upon the realisation that selling volatility — whether that be through shorting the VIX or some other derivative-based method — can be a lucrative (if risky) strategy. This was the big shift in the volatility market. Instead of having a bunch of banks or hedge funds (or de facto, GSEs) sell volatility, you suddenly have a bunch of buy-side funds and retail investors who are interested and able to do so, the latter largely thanks to the explosion in VIX-related products. The big question, per the piece, is whether these new sellers of volatility are more likely to behave differently than traditional vol-sellers. Are they more or less likely to react to abrupt shifts in volatility?

3. Self-reflexive VIX

By September 2015, the VIX is again in the headlines after the unexpected devaluation of the Chinese yuan spooked markets. While the VIX did jump on this news, it was the VVIX (in effect, volatility of volatility) that reached an all-time record. Here’s my article about that: “When there’s a sudden spike in volatility, as occurred last month, the price of near-term VIX futures rises. Meanwhile, volatility players — notably hedge funds and CTAs — scramble to buy protection as they seek either to hedge or cover short positions, causing a feedback loop that encourages near-term futures to rise even further.” CFTC positioning data at the time did suggest a classic short squeeze as investors closed out their short vol positions post the spike. In effect there were said to be two major forces impacting the VIX, systematic volatility sellers as well as VIX-related ETPs that have to buy or sell futures to rebalance. This rebalancing act makes the VIX curve important, a point picked up on by Chris Cole of Artemis Capital in a story I wrote about a month later: “VIX term structure inverted at the greatest degree in history in August, so much so and so fast that many structured products that use simple historical relationships to gauge term structure switching and hedging ratios just couldn’t handle it,” he said. The concern is that the explosion in volatility-trading means more demand to buy or sell futures to rebalance, which could impact the shape of the curve itself.

4. VIX and beyond!

The proliferation of ETPs tied to the VIX is a concern insofar as it affects the volatility landscape, but it’s not the whole story. To explain, let’s go to Bill Gross, who became the poster child for volatility-sellers after publicly saying in June 2014 — while still at Pimco — that the company was selling “insurance, basically, against price movements” to juice returns in an era of low interest rates. Not once did he mention the VIX. It wasn’t until October 2014, after Gross’s abrupt departure from Pimco, that we got a better sense of what that insurance-selling strategy might mean when the U.S. Treasury market experienced a sudden melt-up, of sorts. At the time, there was plenty of talk that Pimco was liquidating some derivatives positions, which ended up having an outsized effect on the underlying cash market. The U.S. government’s report on the episode later mentioned that: “In particular, anecdotal commentary suggested that some dealers had absorbed a portion of the sizable ‘short volatility’ position believed to have been previously maintained by large asset managers. As volatility spiked on October 15, those positions would have prompted some dealers to dynamically hedge this exposure, exacerbating the downward move in yields.” Then, in August of last year, the BIS published a paper on asset managers dabbling in eurodollars including the example of Pimco in 2014, which I wrote up in a piece called “This is where leverage lives in the system.” That article contained a laundry list of potentially risky strategies across rates (viz eurodollars, futures, forwards), credit (using swaptions and swaps) as well as equities (options, VIX ETPs, etc.). What’s my point? I don’t mean to underplay what’s happening with the VIX, but my concern is that if we’re looking for potential flash points in the financial system then we may want to broaden our horizons.

The year in credit

The year in credit

Credit markets, I wrote a lot about them this year. One day some other asset class will grab my attention but for the time being it’s this. Sorry.

Here’s what I wrote about the market in 2015 – or at least, since starting the new gig over at Bloomberg in April. I may have missed a few here and there (and included some fixed income posts that I think are related to over-arching credit themes), but I think this is pretty much covers it.

Happy holidays, and may 2016 be filled with just the right amount of yield.

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It’s volatile all the way down…

It’s volatile all the way down…


The surge in volatility trading strategies and volatility-linked products is impacting volatility itself. I was tempted to break out the tail wagging the dog GIF again for this one, but I’ll keep it simple. Read the below, then read this, and this, and this, and so on.

Market volatility has changed immensely

On Aug. 24, as global markets fell precipitously, one thing was shooting up.

The Chicago Board Options Exchange’s Volatility Index, the VIX, briefly jumped to a level not seen since the depths of the financial crisis. Behind the scenes, however, its esoteric cousin, the VVIX, did one better.

For years, the VIX has been Wall Street’s go-to measure for expected stock market volatility. Derived from the price of options on the S&P 500-stock index, the volatility index has evolved into an asset class of its own and now acts as a benchmark for a host of futures, derivatives, and exchange-traded products to be enjoyed by both big, professional fund managers and mom and pop retail investors.

The dramatic events of last month underscore the degree to which the explosion in the popularity of volatility trading is now feeding on itself, creating booms and busts in implied volatility. Even as the VIX reached a post-crisis intraday high, the VVIX, which looks at the price of options on the VIX to gauge the implied volatility of the index itself, easily surpassed the levels it reached in 2008.

Analysts, investors, and traders point to two market developments that have arguably increased volatility in the world’s most famous volatility index, beginning with the rise of systematic strategies.

It’s a week after this was published and the Vix has since been collapsing after shooting up to that August 24 high.

The Tarf Barf

The Tarf Barf

Hi, Mr. Chief Financial Officer of Generic China Corp. This is John Doe from sales at Solidly Second-Tier Bank. How are you? Listen, I think I have something that might interest you. Ever heard of a Target Redemption Forward? No? Let me explain. It’s a structured product, kind of like a series of exotic options that pay a monthly income as long as the spot yuan exchange rate remains above the strike price. Now, I hate to mention this, but I want to be up front with you, because you know I value your business. The risk here is that if the yuan falls below a certain level—say, 6.2 against the dollar—the option gets knocked out and you have to pay out double the amount. I personally don’t see that happening any time soon. I mean, with USD/CNH trading in this kind of range, we’re talking practically no-risk money.

You’re in? Great!

You already know how this ends (in tears and delta hedging).

Read about the latest slaughter in structured product land over here.

What we didn’t learn about the events of Oct. 15

What we didn’t learn about the events of Oct. 15

This week, the US.government released its report on the events of October 15.

I was disappointed.

The 72-page report has lots of points of interest but doesn’t come up with any definitive reason for the sharp movements in the 10-year U.S. Treasury. More disappointing than that (for me) was the report’s treatment of the events leading up to the day and specifically its very brief mention of volatility selling.

Here’s what the report said:

In addition, market participants reported that some large asset managers had maintained positions structured to profit from a continuation of the low-volatility environment that characterized much of 2014, though data to validate such claims are limited. Some market participants have speculated that a change in the distribution of certain options-specific risk factors among certain firms could have been a contributing factor. In particular, anecdotal commentary suggested that some dealers had absorbed a portion of the sizable “short volatility” position believed to have been previously maintained by large asset managers. As volatility spiked on October 15, those positions would have prompted some dealers to dynamically hedge this exposure, exacerbating the downward move in yields.

Long-time readers of this blog may remember that this is something I’ve written about before, specifically in a piece for the Financial Times entitled: “Caught on the wrong side of the ‘vol’ trade.” Unlike the Oct. 15 report, that article names a specific player who was said to have suddenly stopped selling vol.

“Pimco was a massive seller of volatility and when Gross left they started taking that position back,” says one hedge fund trader. “The Street was still thinking that short was out there. People expected the road to be there and the road wasn’t there.”

Given the debate over whether large asset managers are or are not systemically-important, it’s shame the Oct. 15 report did not dive into this particular theme a bit more.

Tourists caught on the wrong side of the volatility trade?

Tourists caught on the wrong side of the volatility trade?

We know that banks and hedge funds a traditional sellers of volatility. But low interest rates and somnambulant markets have also encouraged asset managers (or “tourists” as the banks and hedgies sometimes call them) to take up the strategy as they seek to juice their returns. It seems … risky.

This story has a lot of stuff in it, including a smallish dive into the events of October 15.

Long the domain of professional speculators like big banks and hedge funds, “selling volatility” — as such wagers are known — became one of the most popular trades of the year as a much wider range of investors piled into bets that asset prices would remain stable.

Now, as the prospect of the Federal Reserve raising interest rates draws increasingly near, the concern is that market volatility will return with a bang in 2015 and those investors caught on the wrong side of the revival will suffer badly.

“Volatility is a zero-sum game — for every buyer there is a seller. But what has changed is the type of sellers,” says Maneesh Deshpande at Barclays.

Caught on the wrong side of the ‘vol’ trade

October 15. A financial markets whodunnit.

October 15. A financial markets whodunnit.

On October 15, prices of US government bonds – one of the most liquid markets in the world – whipsawed violently and sparked a wave of speculation on Wall Street as to the culprit(s) behind the wild moves.

Here’s a longish analysis of what happened. The key suspects: lack of liquidity, the rise of electronic trading, a classic gamma trap (possibly sparked by the scuppering of the AbbVie/Shire deal) and much, much more.

… On October 15, the yield on the benchmark 10-year US government bond, which moves inversely to price, plunged 33 basis points to 1.86 per cent before rising to settle at 2.13 per cent. While that may not seem like much, analysts say the move was seven standard deviations away from its intraday norm – meaning it might be expected to occur once every 1.6bn years.

For several minutes, Wall Street stood still as traders watched their screens in disbelief. Electronic pricing machines, which now play a bigger role than ever in the trading of Treasuries, were halted and orders cancelled by nervous dealers as prices see-sawed.

The events have sparked a financial “whodunnit” as investors, traders and regulators seek to understand what happened – and to determine whether October 15 was a unique event or a harbinger of further perilous trading conditions to come.

Bonds: Anatomy of a market meltdown