Zero Lessons Learned: Retail Investors Are Again Pouring Money Into Short VIX ETFs

After last Monday's terminal event for the XIV - which at the time was the second largest inverse VIX ETN, before a the so-called volocaust and the subsequent record VIX eruption, resulted in a 96% NAV loss and subsequent termination "acceleration"...

... one would assume that retail investors - the target audience of volatility ETPs - had learned their lesson and after suffering a near total wipeout, would stop shorting vol and in general, no longer collect pennies in front of steamrollers. One would be wrong.

* * *

But first, a quick reminder oh how various investor classes use VIX-linked products (including options, ETNs and ETFs).

At the top are the institutional traders, virtually all of whom have been forced after a decade of central bank yield and vol suppression to turn massively short-vol, and use the decay in theta as a source of "dividend" income. According to

Fasanara Capital, the consolidated value at risk among all explicit and synthetic institutional vol shorters is about $22 trillion. One way of gauging institutional investors’ demand for equity hedges, particularly tail risk hedges, is by looking at put and call open interest on VIX options. The use of VIX options has increased significantly since the Lehman crisis by investors seeking to hedge against equity tail risk, credit exposure or volatility exposure. As JPM confirm, several investor types such as vol targeting (equity or multi asset) funds or risk parity funds are structurally short volatility and "VIX calls provide the most direct and liquid way to hedge their short volatility exposure."

The JPMorgan chart above shows the VIX put and call open interest, and suggests that after the ratio of calls to puts increased for much of 2017 it reached a high in mid-January. Since then, a rise in put interest has brought the ratio back to its average level since 2014. One explanation is that the recent collapse in equity index volatility to record lows induced demand for protection against a volatility spike. And with such a spike materializing this week, institutional investors appear to have taken profit on some of these hedges this week.

What about retail investors? This is where things get messy.

First, the explainable behavior: retail investors tend to buy VIX ETFs as equity hedges. When it comes to plain vanilla non-inverse VIX ETFs - which have seen their value implode over the years as a result of a artificial, central bank-induced decline in volatility - retail investors continued to buy VIX ETFs until mid-January. Then, similar to the behavior of institutional investors over the past two weeks amid rising vol, retail investors have been sharply exiting Vol hedges.

And now the inexplicable: after getting absolutely crushed on their inverse vol exposure, retail investors have... doubled down, and according to Bloomberg data and JPM calculations, inflows into inverse VIX ETFs, i.e. selling volatility, have increased sharply over the past two weeks.  This can be seen on the black line in the chart below, where inflows to inverse VIX ETF has soared by $2 billion since the end of January. Specifically, last week saw net inflows of around $850mn, and despite the collapse in prices of inverse VIX ETFs early this week net inflows in dollar terms increased to just over $1bn.

In other words, the turmoil in inverse VIX ETNs has thus not deterred retail investors from pouring money again into short VIX ETFs, similar to their behavior in previous spikes in volatility. If anything, retail investors are doubling - and in some cases quadrupling - down on bets that vol will drop.

Why? Very simple.

As we showed earlier, after the events of the last two weeks, Bank of America's "Critical Stress Signal" was triggered, which while pre-2013 indicated that a major market selloff was imminent, has since 2013 transformed into a "contrarian buy" signal, as it preceded - on 5 out of 5 occasions - central bank intervention, either actual or verbal and a surge in risk assets.

So why are retail investors betting that VIX will crash from its lofty 30+ levels?

Because they are confident it will be 6 out of 6.

Because they are certain that should things get worse, the Fed will once again step in and stabilize markets, which as we explained earlier, could be a fatal gamble this time around.

And as a result, the Fed is again trapped: if the selloff continues - or accelerates - next week will face a lose-lose dilemma - bail out retail (and institutional) vol sellers, and while preventing trillions in losses, lose all credibility and confirm that the "coordinated recovery and strong economy" narrative was a lie all along, while derailing what is likely the last tightening cycle; or allow normalization to take place, and watch as trillions vaporize from the Fed's artificial "wealth effect." 

We wish Jay Powell the best of luck as he faces the most critical question of his career just days into his tenure as the Fed's new chair, and wish to remind him of what he said at the October 2012 FOMC meeting:

I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.


buzzsaw99 Sat, 02/10/2018 - 14:47 Permalink

bail out retail (and institutional) vol sellers, and while preventing trillions in losses, lose all credibility and confirm...

they have zero credibilty now. that's why we saw a historic melt up in global equities in the face of fed rate hikes. the fed are nothing but socialist clowns who will do qe 4evah.

A sow that is washed returns to her wallow.

buzzsaw99 Sat, 02/10/2018 - 14:51 Permalink

It's not the Federal Reserve's job to protect investors from losses in the stock market, Minneapolis Fed President Neel Kashkari said Tuesday.


The fuck you say.  LMAO!!

Cutter Sat, 02/10/2018 - 15:10 Permalink

Two reasons not discussed. First, these products by the very nature of the futures they are using continually decline. Yes, things like VXX went down because of record low vol, but they also went down because of the way they are structured. Even if vol stayed perfectly stable, holding something like VXX long term is a loser. Second, everyone thinks uncle Fed is coming to the rescue and will push vol back down. They are going to be disappointed. 

Da Nut Job Sat, 02/10/2018 - 15:16 Permalink

I may have shot five rounds or I may have shot six. To be honest with you, in all that shooting, I'm not really sure myself. So you have to ask yourself one question. Do you feel lucky?  Well, do you PUNK???

MusicIsYou Sat, 02/10/2018 - 15:31 Permalink

I don't read these charts and articles because they're increasingly designed by people with lack of focus and reduced attention spans (millennials aren't the only ones with reduced attention spans). Moreover these economic articles are becoming a tower of Babel full of blathering babble. I bet people don't even know why when Charlie Brown talks on the phone the adults are saying wah wah wah.

MusicIsYou Aireannpure Sat, 02/10/2018 - 15:55 Permalink

And everytime the Fed acts it creates a larger future conundrum. That's why God said when it comes to pass there will be more death and destruction than there ever was since the beginning. In that God knows the devil,  God created the devil and the devil doesn't want the system to reset but it's not up to the devil. The devil will say the reset is the devil's work,  because that's how the devil rolls,  and in a way the devil is correct because the devil kicked the can down the road. Ever noticed that devil is lived spelled backwards? Yep,  the devil wants to go on living so he kicks the can down the road. You can distinguish people by their deeds, and kicking the can down the road is a deed. 

In reply to by Aireannpure

Hongcha Sat, 02/10/2018 - 16:35 Permalink

Everyone is overreacting.  This is the big boys rakin' the vig.  It's been a while and people forgot what selling looks like.

Back on track soon enough.  The big boys run the house and the house makes its cut sawtoothing the charts and not by slaughtering the flock.

The flock's breathless panic is useful to the hunter.  It's your friend.

We are like krill circling while killer whales battle it out.  Grabbing a few shreds here and there.  Enjoy!

Knobbius Sat, 02/10/2018 - 17:03 Permalink

People (including those who wrote this article) are ignoring the obvious.  Shorting the VIX when it’s sitting at 9-10 is nuts.  Perfectly valid to question shorting something that’s sitting at an all-time low.  I gave up on covered calls a year ago because the premiums were just weren’t worth it. Fast forward to this past week, however, with the VIX up near 40, and going short Vol makes more sense.


See how that works?  Short high, cover low?  Buehler?

Nelbev Sun, 02/11/2018 - 03:04 Permalink

If you look at the VIX futures out few months, we have backwardation, thus markets think things will calm down and the VIX will fall (eventually) as it has in the past, it is mean reversing to a degree with an odd distribution like a bouncing ball which gets shot up once in a while.  So the VIX is at 29, say 20-24 is a good call in a month or lower like 15 six months out easy, but not record low 10 again for some time, maybe one or two spikes (CPI next week if bad, Fed meeting in March), but still return back down.  A short VIX position is completely rational after a spike.  Volocaust is not something which is permanent, it is something which happens and ends like the weather, calm, stormy.  On the other end, short VIX futures with backwardation is money loser for time except for a short term in/out play on calm returning.  Things have changed or reversed, the picking up pennies in front of a steam roller play now is longing cheaper VIX futures and expecting to rise to higher spot, works unless VIX falls more than reverse degradation gains or blows up if backwardation returns back to contango, but given past the latter will eventually happen, question is if that happens slow or fast.  I shorted vol Friday in rally to close, and was long prior, but will likely write short term covered calls on it given current fatter than fat time premiums which smell and taste like bacon.

JLarryL Sun, 02/11/2018 - 19:50 Permalink

Another option: The Fed will step in but AFTER renewed carnage threatens to take back ALL 2017 gains. Intervention will come too late to save the volatility traders, who will have their Waterloo.

The carnage will be big enough to simultaneously cause money to flee into bonds, thus sinking the record bond short position. More big losers.

The big winners? Well, the banks were complaining about low volatility. Their profits should be up significantly. Being in an advantageous position, maybe they even gave things a "nudge" here and there. ;-)