If there is one foolproof way to make money in today's markets, it's selling any and every blip higher in volatility - in fact it's so easy a Target manager can do it and make millions. However, something very different happened last week...
3 of the 4 trading days last week saw SVXY fund outflows with Wednesday the largest single-day outflow in history...
The Short VIX ETF SVXY, up more than 150% this year amid a slump in equity swings, lost almost $330 million in four days - the biggest weekly outflow in history...
While traders added money to a note that climbs with increasing turbulence.
Should the VIX suddenly spike, the repercussions of such a move would be further complicated by the billions of dollars sitting in various VIX-linked ETFs. Because individuals sellers would probably disappear from the market in such a situation, the ETF market makers would find it nearly impossible to hedge their positions, potentially triggering the dissolution of the funds, or even the collapse of some of these firms. The Macro Tourist's Kevin Muir explains:
There’s $1.2 billion of the XIV, which is the short ETF. There’s $1.3 billion of the SVXY, which is another short one. These are staggering numbers.
In my days, when I was on the institutional desk, we had this big – I did index arbitrage, and we used to go out and buy the baskets and sell the futures. One day the risk manager came to me and said, if you had to take this position off (because we had accumulated this big position) how long would it take you? And who would do it?
And I said, the reality is that there’s nobody. You know, we were the biggest player in the market and there was nobody that was going to take this off of us. The only way was to go all the way to expiry.
Well, the reality is that these numbers are way bigger than any market player can absorb. And, if we get a situation where – as Francesco says, all it’s going to take is a return of the VIX from its current level of 10 to its average level of 18 or 19 to wipe out these products.
I guess that’s the point that I want to make: If you’re actually owning these things, you should be aware that all it will take is a move of 80% and then they’re going to wind down these products. So the XIV, when it moves up, if all of a sudden VIX goes from 10 to 18 in a day, they’re going to wind down that product.
And what’s going to be really scary is the amount of VIX futures that is going to have to be bought, because they’re short all those VIX futures and they’re going to have to buy them back.
And I just don’t know who’s going to sell it to them. For the first time – for a long time, I didn’t view this VIX as that big a deal, and there were some smart guys like Jesse Felder that were going on about it – I just think that it has been taken to a level that is becoming increasingly worrisome. And it actually could create a market dislocation in itself.
And what is it Warren Buffett says? What the wise man does in the beginning the fool does in the end. Well, VIX, at this point, we’re hitting a point where if you’re actually continuing to bet on it you’re going to be in the fool category.
Because it’s not going to take much to have a big spike that wipes a lot of people out. And it’s actually very, very worrisome.
Of course, it would take a large intraday move to trigger a truly catastrophic spike in the VIX. But at least one analyst, Bank of America’s Michael Hartnett – whose work we have cited here – believes there could be a 1987-style crash in the early months of 2018. Hartnett’s reasoning? The bearish positioning seen at the beginning of 2017 has completely flipped. Investors’ long positions are larger than they’ve been in years.
And as we’ve repeatedly pointed out, with volatility and volume so subdued, hedge funds have remained overwhelmingly short vol, fearful of missing out on even one tick of the torrid rally for fear of pissing off their clients.
One things for certain: Given the market’s already dramatically overextended rally, the day of reckoning is coming. The only question is will it be a steady decline, or will it happen suddenly?
Given the incredibly stretched nature of positioning, the latter scenario, Muir and Co. believe, seems far more likely.