January 22, 2020
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We’re honestly not totally sure if we’ll ever stop talking about the VIX. We correctly guessed (not that hard) the VIX was going to be a big part of the 2019 conversation, and we’re back 365 days later in our Managed Futures Outlook 2020 talking about it again:
… did anything really change in terms of the VIX market [from 2018’s spike to 2019]? Did the VIXmageddon cause people to stop selling volatility as an investment strategy? Have there been more volatility spikes? Have the vol spikes that have happened been more long lived? Have speculators stopped selling VIX futures en masse.
The answers, of course, are no, no, no, no, and absolutely not. As can be seen by the CFTC position reporting numbers, the VIX trade is alive and well, thank you very much. And it’s not just alive. It’s bigger than ever. The net short position of the ‘non commercials’ (read, speculators) sits at about 200,000 contracts, which is about 25% more than the previous record at the end of 2017 right before the VIXmageddon event. And as can be seen by the 8 year down trend line – this isn’t a new story. Investors have been increasingly adding short vol exposure via VIX futures to their investment mix for the better part of 8 years. And that’s just in the VIX futures. That’s not even including the yield enhancement strategies selling options (short volatility) to get a little extra yield or other types of volatility harvesting strategies across all types of option markets, be it individual stock names, stock indices here and abroad, or even bond and commodity markets. Here’s a note from UBS’s “Year Ahead 2020” driving the point home that vol selling isn’t some esoteric outlier of an investment strategy. It’s an outright recommendation and portfolio sleeve at some of the largest investment shops in the world.
Put writing. A put writing strategy might be relevant for investors who expect rangebound markets and higher volatility, for those looking to buy into market dips in a disciplined way, or for those looking to diversify their sources of portfolio income in a low-yield world.
That’s all fine and good, and large pensions and endowments adding some short volatility as an equity replacement or yield strategy isn’t all that crazy. They know the risks and know what they’re getting into. But the question of where the tipping point is… of when does the tail start to wag the dog, is as poignant as ever.
And that’s because volatility and the VIX are now a player in the game, not just the score, to paraphrase a line from Chris Cole at Artemis. Volatility is not just a measure anymore, but rather is invested IN – massively.
The consensus seems to be that the movement into this volatility as a product space has resulted in fewer vol spikes and shorter lived ones when they do happen. The taller heads we talked about before. But is that a feature, or a bug? Does that pinching in of the normal shape because of that investor appetite necessarily create fatter tails? Does it mean more Feb 18s in our future? Worse? And what sort of portfolio should investors be looking at knowing this segment of the market is growing? Long vol… comes to mind.
If they are selling vol, how do they make it more anti-fragile and able to withstand the next VIXmageddon? Keep an eye on short vol exposure in 2020 and a new batch of long vol managers trying to profit from the eventual spike without losing too much until it comes.
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