The VIX Article No One Will Like

Tyler Durden's picture

Authored by Kevin Muir via,

I am pretty sure no one will like today’s post. Half of my readers will be disappointed by the discussion of VIX product intricacies, and the ones not put off by the technical nature of volatility pricing, will throw bricks at me because I don’t subscribe to the notion there is a giant VIX short position ready to cover in a sickening swoosh higher when the day of reckoning finally descends.

Before we start, let me posit two points. The first is obvious. The VIX is currently quite low. Over the past few days we have even flirted with single digits. It would be perfectly natural for volatility to pick back up to mid teens in the coming weeks. I am not ruling that out, so when you read my post, please keep that in mind.

My second caveat is that I am by no means a VIX expert. In my former life, I traded stock index options on an institutional desk, so it’s not like I am a complete noob, but there are a myriad of really smart people who know way more than me. Many of these individuals have the opposite viewpoint than mine, so there is a decent chance I am way off base with my analysis, but making a fool of myself with an out of consensus view has never stopped me before, so why start now?

The narrative overwhelmingly embraced by most of the street is that there is a monster VIX short position out there, and that this volatility selling is a disaster in waiting. This camp has some impressive alumni. For the past year, the smart as a tack Jesse Felder, has been writing pieces about this risk. If you want to understand his point of view, check out the article from last summer - “The Short Vol Trade has gotten completely out of hand”. I love Jesse’s writing, and taking the other side of his trade gives me pause, but I respectfully suggest he might be wrong on this one.

It seems to me that the VIX bulls’ main argument focuses on the belief there is a huge amount of volatility selling occurring. Their main piece of evidence centers around the dramatic increase in VIX long ETF product short interest.

Here is a common “nightmare” VXX ETF chart that gets passed around.

Holy shit! That does look scary. Short interest going from under 15 million shares to 65 million in less than a year.

But instead of hyperventilating about this, let’s step back and take a moment to think.

Let’s start with the fact that during this time the price of the VXX ETF went from $50 to $15, so let’s redraw the chart with the notional amount of VXX sold short instead.

But, but, but… Suddenly that doesn’t seem quite as frightening.

I can hear the VIX bulls’ next argument already. The short interest versus current shares outstanding is almost 100%, so that represents a ton of pent up buying that needs to be covered. Sure, maybe it is less in notional value, but there is still a sizable short position that will need to be bought.

There is no disputing the fact that approximately 100% of the VXX float is sold short. In a regular stock, this would be insane. Eventually this short position would need to be covered, and the market would be correct to worry about a short squeeze.

But VXX is not a regular stock. It is an ETF. And ETFs can be created and redeemed by market makers.

When I worked as an institutional ETF trader, we didn’t worry about having inventory to fill buy orders. We knew that if we needed to, we could always create ETF shares as the need arose. So we wouldn’t think twice about selling short the ETF, and hedging it with a long position in the underlying index. Our actual ETF versus underlying position had more to do with dividends, tax and borrow rates than anything else.

I am not familiar with dealers’ biases in terms of their VXX inventories. Yet it sure seems the short position is merely a reflection of the shares outstanding. The two are moving hand in hand.

If I had to guess, I would argue that, contrary to what is widely believed, end users are not actively selling short VXX. Instead, the exact opposite is occurring.

End users are buying VXX by the fistful. Dealers are shorting the VXX to them, and as need arises, they are creating more.

I understand that this is exactly contrary to what everyone is shouting about. This would mean that instead of a sizable short position in VIX, there might actually be a big long.

Here is where it gets complicated. For every VIX buyer, there needs to be a VIX seller. And even though dealers could attempt to hedge it in the underlying option market, again, every option seller needs an option buyer. And then from there, it really depends on which party is delta hedging, and which is letting the risk run. So the real question is who are the buyers and sellers.

I agree with many of the VIX bulls’ who claim there is pervasive volatility selling occurring by institutions looking to pick up yield in this NIRP environment.

But on the other hand, there is equally massive volatility buying by retail and speculative accounts who believe the next crash is right around the corner. This is why VXX shares outstanding is exploding higher.

If there was truly a bias towards volatility selling, then the XIV’s (which is the short volatility ETF) shares outstanding should be exploding higher as retail chase the hot product. Yet, instead, the shares outstanding are collapsing.

I am aware that these ETF products represent only one portion of the VIX trade. There are futures on VIX, and even more complicated institutional products, like variance swaps. Maybe there is a monster short volatility position out there at the OTC level that I am unaware of. I am not ruling it out.

But I am suggesting that the short term hot money is long VIX, not the other way round. All you need to do is look at the amount of complaining occurring about the lack of volatility. If there really was this massive speculative short vol position, wouldn’t traders be whooping it up? Instead, all I hear is moaning about the collapsing VIX.

Many traders have written about the fact that the current low VIX is not surprising given the lack of actual movement in the index. But few are able to explain the root cause.

Well, here is a thought for you. We all know the Central Banks are becoming increasingly active in the equity markets. And the most interesting part of their involvement can best be demonstrated by the Bank of Japan’s equity purchase program. The BoJ reports their equity purchases after the fact, so we know on which days they have been active. The BoJ has a definite strategy to buy on days when stocks are down on the day. The BoJ does not regularly buy stocks regardless of the price (unlike the scheduled POMO purchases previously made by the Fed in the bond market during their QE programs), but instead, the BoJ waits for weakness and stands in there with blue tickets. This has a massive dampening affect on volatility.

I don’t know if this is enough to cause the worldwide decline in volatility that we have experienced. But I also know that periods of calm are not unprecedented.

I am not some VIX super bear, who thinks all is well with the world, and that stocks are a terrific buy because the economic fundamentals are so rosy. The financial system is way more precariously perched than most believe. Yet I am not sure it will resolve itself with an equity crash and VIX explosion higher.

Eventually, I see volatility increasing, but not for the reasons most believe. I suspect we will have a 1999 style equity melt up that also includes an increase in volatility.

But that’s longer term. In the meantime, I think the weak hands are long VIX, not the other way round. I suspect we will see record lows before this is all through. Everyone is looking for a VIX explosion, I think it’s more probable that we see a VIX capitulation.

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BlueHorseShoeLovesDT's picture

I agree vix is going to collapse

WTFRLY's picture

Whatever, this article is pure sex

CJgipper's picture

Betting on the VIX to increase is betting against the Federal Reserve Bank.  They can stay solvent longer than you.

Bam_Man's picture

"But VXX is not a regular stock. It is an ETF. And ETFs can be created and redeemed by market makers."


Market Makers can create ETF shares out of thin air, without having to buy any of the underlying instrument AT ALL first?

In other words, the insanely gigantic VXX short position could theoretically be covered by new VXX ETF shares created out of thin air by "Market Makers"?

No f***ing way, Jose.

BlueHorseShoeLovesDT's picture

Vix trading is the deep end of the pool, I would recommend most not to attempt it.

WhatCouldGoWrong's picture

Sorry, Bam_Man but that is the nature of the profound corruption we live in. Last year the short position on the VXX hit 3x the float.... 3 times the available shares!!. That is not possible.... unless you are the Exchange Stabalization Fund or one of the Primary Dealers that can naked short with impunity at the behest of the power stucture. If you make up the share out of thin air, sell it into the market, do you have to cover that share in the same thin air? Currently we have about 300 million shares a day with a failure to deliver. IT IS NOT A MARKET! It is the financial equivalent of CNN. 

WhatCouldGoWrong's picture

Sorry, Bam_Man but that is the nature of the profound corruption we live in. Last year the short position on the VXX hit 3x the float.... 3 times the available shares!!. That is not possible.... unless you are the Exchange Stabalization Fund or one of the Primary Dealers that can naked short with impunity at the behest of the power stucture. If you make up the share out of thin air, sell it into the market, do you have to cover that share in the same thin air? Currently we have about 300 million shares a day with a failure to deliver. IT IS NOT A MARKET! It is the financial equivalent of CNN. 

spastic_colon's picture

what were interest rates the last 2 times VIX went under 10? theres your answer.....VIX could hit 3 if thats the case....the other problem is EVERYONE is talking about how low the VIX is right now.

Vlad the Inhaler's picture

Jibber jabber.  VIX spot is just a fancy calculation of SPY put/call ratio.  

Piranha's picture

why doesnt the author calculate the notional value of XIV since its price has gone up, instead just counting outstanding shares....if you do A you have to do B if you are going to draw conclusions of it

Zeej's picture

The entire article is misleading. He is just looking to present the other side to the everyone is shorting volatality argument

Snaffew's picture

I can't argue with the author, but if the market does have a correction near term, there is no way the VIX or the VXX goes down with the indices.

xrxs's picture

I like this VIX article. I found it informative,  well reasoned,  and I appreciated the caveats at the outset - intellectually honest.  Great point about there needing to be buyers on the long end.  I imagine there is some standard buying for portfolio hedging, but with all the additional buying, either there's a lot more hedging going on, or there is a pretty large speculative market. It seems like that end is always going to get roasted by contango and roll over. Wonder what the dynamics on that end of the trade is. Who is it,  and why do they keep losing money on the speculative side.

asteroids's picture

Eh? There is NO risk to this market due to FED and other CB intervention. There is also NO value. Being long or short is like dividing by zero. Doesn't make any sense. But, if you can't help yourself you are an idiot if you are long the VXX anything more than a few seconds. Good Luck.

Zeej's picture

VIX FUTURES run the show, not these stupid etf's. Also he isnt covering the entire space of vix etf's. SVXY ZIV VXZ TVIX UVXY etc

but most importantly he is not talking about VIX futures which control the vix. Futures run the entire market

Cute theories but meaningless.  

Kev needs to reread -->


Arnold's picture

The word cloud return on UVXY is below zero.

Although it seems to have some diminishing predictive value.
Not something I would want to, or be able to buy.
I respect My Beer money better than that.

argentuman's picture

Leave us not forsake XIV and her siblings.

ThanksIwillHaveAnother's picture

The VIX doesn't measure intra-day volatility well, it is after the fact.   Get rid of the VIX.

Fundies's picture

I've got VIX envy.

Arnold's picture

I understood about a third of his explaination.

However it sounds similar to the COMEX motto:

Your settlements will be on paper at a price determined by us.

Dewey Cheatum and Howe's picture

the VIX is simply the latest whipping boy of the algo-droids

CHX13's picture

The vexing vix... S.O.S. Markets can remain irrational longer than you can stay solvent, so whatever you do, proceed with caution. My take on it all is that they will paper everything up, everything, and thus VIX could indeed trend lower unless there is a majorsell-off... but that would again be betting against the PPT, the FED, SNB et al. On the other hand, as the real economy around the globe deteriorates, this will at some point affect the valuations via bad earnings etc (see Macey, Snap,...) and there will be a Minky-ish "holy crap" moment and things will fall apart in very short order, leading to some sort of monetary reset. But this could still be a good while away, as MSM is doing a good job stone-walling all the bad economic news.

quesnay's picture

The VIX is experience peak shorts, but "everyone is looking for VIX explosion upwards". Hmmm. You keep using that word (everyone). I don't think that word means what you think it means. One would think the shorts don't expect the VIX to explode upwards (no?)

hawaiian waverider's picture

everyone for article=retail.  Shorts=institutional.. that has a mandate to sell vol.  The question is the institutional rules have any way to throttle back risk once it begins to run, without fueling into it?  This is what we will find out. 

quesnay's picture

Ah okay. That could be then. In the old days this would be a no brainer. Buy and wait for the inevitable spike 'one day'. In the new reality of constant intervention and manipulation, who knows ...

Tonterias's picture

Vix Up, with Dow Jones new records

ChanceIs's picture

Mean reversion bitchez.  Volitility should spike well past the LT average as the proverbial "beach ball" rises to the surface.

This does coincide with the PM selloff.  Gold/silver are fear trades and when volitility = fear increases, so does the PM price.

Author fails to mention that the VIX is downward biased.  That is it weighs put prices more heavily than call prices.  Put prices increase with downward fears or actual movements.  Hence if VIX is falling we have "Blue skies smiling at me, nothing but blue skies do I see."  (Thank you Louie and Ella.)  The ETF's are often constructed with options, which decay over time.  So there is a LT downward bias.

Author provides some valuable insights which I would not have imagined.  Having said that I am in the VIX snap-back camp.  Remember the dot-com bubble?  Neither does most of Wall Street.  The trees grow to the skies bitchez.  BTFD. 

hawaiian waverider's picture

Are more and more places like tastytrade, optionsalpha etc. are creating more and more options sellers and, Vix reflects the price of options so makes sense that price is going down as more sellers=lower prices on top of all the usual lov vol ETF's such as SPLV?  Interesting post and time for sure

Boris Badenov's picture

If it involves numbers on a screen, Goldman Chase Merrill and Morgan can exploit it. 

The rest of you guys are hallucinating on the spiked Kool-Aid (r)

Nomad Trader's picture

I used to work on an EQD desk and I can tell you two things:

1. The bank was a never ending seller of volatility that came as a result of securitization and corporate deals done on the structured products desk. 

2. The vast majority of vol trading is OTC and nobody knows what they are doing except the client and the dealer. Exchange listed VIX derivatives along with retail ETFs are a meaningless drop in the bucket.