Co-Inventor Of VIX Warns Low Volatility Is Not New Normal

Tyler Durden's picture

"Historically there seems to be a new group of people each time that underappreciates the very significant risks of being short volatility and wants to learn this expensive lesson."

Co-inventor of the VIX index, Sandy Rattray is CIO of Man Group, CEO of Man AHL, and a member of the Man Executive Committee, and he has a clear message for investors - he believes it is extremely unlikely that today’s low realized volatility represents a 'new normal'.

In conversation with Goldman Sachs' Allison Nathan in her bi-weekly 'Top Of Mind' letter, Rattray warns "The market is underpricing tail risk today."


Asked about the current popularity of volatility-selling, Rattray responds...

Across many previous cycles, volatility selling tends to be quite popular after long periods of relatively low volatility and unpopular just after volatility has spiked - the reverse of what would seem to be rational.


So the fact that there’s lots of volatility selling at the moment isn’t particularly surprising in my view. Historically there seems to be a new group of people each time that underappreciates the very significant risks of being short volatility and wants to learn this expensive lesson.


In my view, shorting volatility should only comprise a relatively small part of a portfolio, and should have a clear risk-management process around it. If you don’t follow those two rules, then you could potentially end up in significant trouble. There is no question that these short-vol strategies can pose significant risk to individual investors pursuing them if they are not managed appropriately.


That said, I’m not sure these volatility sellers are impacting the market any more than usual. The reality is the low levels of the VIX are fairly consistent with low levels of realized volatility; S&P 500 30-day realized volatility is about 6.6 now, and the VIX is about 10.6, versus a long-term spread between implied and realized volatility of about three to four points. So I don’t think we can blame much on volatility sellers themselves. I see them as playing their traditional role of keeping supply and demand for implied volatility in equilibrium.

And in that context, Rattray has some advice for traders and investors today...

People often ask whether we have a new, lower normal in realized volatility. I believe with some conviction that we don’t. The very low-volatility environment today will end at some point, although it is very hard to forecast why and when that will happen. But we’ve had a fairly strong and continuous rally in equity markets around the world since 2009, and equities in a number of countries, particularly the US, don’t look terribly cheap today in my view. That does not mean that equities are going to correct in the near term. But it is unimaginable that equities don’t correct at some point.

And echoing JPMorgan's Kolanovich...,

The focus is now back on central banks, with the probability of a June 14th hike rising after the FOMC meeting yesterday (probability now at ~80%). A potential risk-off scenario could be a combination of macroeconomic data slowing, but the Fed proceeding with normalization. Neither a modest macro slowdown nor Fed tightening is likely to tip over the market on its own. However, if it happens in the seasonally weak time period, and if it trips up some of the volatility sensitive strategies (e.g., volatility selling, volatility targeting, etc.) the increase of volatility could be more substantial. For these reasons investors should closely monitor incoming macro data

and Paul Tudor Jones...

Just as portfolio insurance caused the 1987 rout, he says, the new danger zone is the half-trillion dollars in risk parity funds. These funds aim to systematically spread risk equally across different asset classes by putting more money in lower volatility securities and less in those whose prices move more dramatically. Because risk-parity funds have been scooping up equities of late as volatility hit historic lows, some market participants, Jones included, believe they’ll be forced to dump them quickly in a stock tumble, exacerbating any decline.


“Risk parity,” Jones told the Goldman audience, “will be the hammer on the downside.”


Indeed, with all that low-vol leveraged, it wouldn't be the first time.


Rattray sees one group in particular as a potential catalyst...

One concern is that many people choose to scale their positions by the level of realized volatility, which means there could be very large positions out there today with potentially significant leverage that might be vulnerable should volatility rise whether due to a tail risk event or other developments in the market.


So it is important that investors have a plan for when the market environment changes. That plan could potentially involve a hedging strategy, a fund-management strategy, or it could come down to asset allocation or rebalancing—though rebalancing, of course, may exacerbate drawdowns. One size does not fit all here, so there is no one clear strategy to pursue.

What is clear, Rattray concludes, is that there will be a sell-off in risk assets at some point, and the investors who are unprepared are those who will potentially fare the worst.

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Turin Turambar's picture

LOL, he used the word "market."  BAHAHAHAHA!!!!

Yen Cross's picture

  We clearly need a quadruple VIX[Q-VIX] with inverse  m-5 <>50% Nasdaq weighted, skew index.  You should be able to trade it by the tick.

knukles's picture

Are there options for the triple witching hour?
All I can tell y'all is with a contango term structure every last VIX product one goes long is subject to massive money losing roll down.

Yen Cross's picture

  Yes knuks, when there's 5 minutes before closing... On the right chart AXIS we list xag & xau prices, then hand out darts and eye covers.

  Who ever gets closest to the Triagulated close of Q-Vix-xag-xau, gets an Aquaman towel, and Wonder Woman toaster.

Yen Cross's picture

    In that time, I'm sure you are--- ;-)

auricle's picture

VIX means very little when the cost of capital is zero and you have a printing press. 

Davidduke2000's picture

Low volatility? the market is more volatile than ever, one morning people would wake up and the market drops 2000 point in  a single day.

atomp's picture

You spelled "rips" wrong.

Blankfuck's picture

Here is a perfect example of the con game that was created by this group. What a con game it is!   People like myself who lost dearly on this lie of an ETF. I just dont know where I can find these people. I would like to a a private time with them behind closed doors in an unkown place. Set up a meeting please someone

Herdee's picture

Update on Gold, the inverse of the Dollar:

DEMIZEN's picture

i read this article twice, and i still dont understand. the market is underpricing the risk? isnt that why we have VIX?

OregonGrown's picture

"They" are manipulating the VIX artificially low via leveraged options, to give the appearance of calm waters...  Which inducethe algo's to buy equities hand over fist.  I am willing to bet my LEFT NUT that the VIX will NEVER reach what it hit in 2008.... We have conjured WAY TOO MANY DOLLARS out of thin air, for that to ever happen again!


Let the hyper-Inflation of ALL ASSETS ....and decline of ALL currencies begin.


Dow to 100K   ...... Fucking Crooks!

Vlad the Inhaler's picture

You can't manipulate the spot VIX because it's calculated from SPY puts and calls.  The futures and ETFs yes.

OregonGrown's picture

Please correct me if i am wrong but If one is using a "put" and "call", isnt the VIX BY DEFINITION a levered option trade.... no?

El Hosel's picture

Short VOL? ... Would have worked pretty well for the past 7 years, so you are saying the new new normal is going to be different? When?

Yen Cross's picture

 So that's your tarding thesis?  That's what I would have asked.

 Then the snowflake would have explained how he/she writes ALGO's in it's Mothers basement freezer.

whatisthat's picture

Oh please more useless propaganda on bogus investment data...

Erwin643's picture

This article is Tyler telling people who trade SVXY/UVXY/TVIX: