Trader Who Called Last Week's 'Volocaust' Says "This Is Just An Appetizer"

Professionals investors are still digesting the implications of last week's explosion of volatility, while some retail traders are struggling to cope with the loss of years' worth of work.

Meanwhile, one man, who was fortunate enough to have his warnings about the possibility of an explosion of volatility triggered by a dangerously large short-gamma positioning in markets documented by the New York Times, is sitting pretty as his illustration of the risks associated with the market's dangerous sense of calm have proven to be almost eerily correct.



Ironically, Cole doesn't see it that way. So he joined Erik Townsend during a special "postgame" session of Townsend's weekly MacroVoices podcast to offer his two cents on the crash, what caused it, and what he expects will happen next.

While Cole is happy to accept the back-patting and congratulations for having foretold in near-perfect detail the dynamics that would drive this week's volatility explosion, those who read our piece summarizing Cole's (uncannily well-timed) interview two weeks ago will remember that short-vol ETPs like XIV represent only a fraction of the collective $2 trillion short-gamma position that touches nearly every corner of the market.

Other components of what calls the 'implicit' gamma short - which we've touched on this week - include $600 billion invested in risk-parity strategies, $400 billion in volatility-control funds. And $250 billion of risk premium strategies...

Rather than buy the dip, Cole ominously warned that it's more likely this is the beginning of a much larger selloff.

Or, as Kevin Spacey's character put it in the movie "Margin Call", because of vulnerabilities related to the market's massively short gamma positioning, "there will be turmoil in the markets for the foreseeable future."

Everyone talks – congratulations about calling this. Well, I don’t think what I’ve really talked about has come to pass yet. The VIX ETPs are the smallest portion of the global short-vol trade. Talk about this idea of about 1.5 to 2 trillion dollars’ worth of short-vol exposure, both explicit and implicit.

Explicit short volatility are VIX exchange-rated products and vol overwriting funds. You know, the VIX ETPs are only 5 billion dollars.

You have 1.5 trillion of implicit short-volatility strategies, strategies that may not be directly shorting options, but use financial engineering to mimic the components of a short-option portfolio. About 1.5 trillion dollars’ worth of these, of exposure, this is what we’re seeing come online now.

This is the real risk. So stocks and bonds sell off together. You have disorderly unwind withdrawal of liquidity. And then, all of a sudden, increasing volatility results in a quick deleveraging of these implicit short-volatility strategies. And this will drive the next leg of the crisis.

So, people say congratulations, you called the short-vol trade. No, nothing has happened yet. This is an appetizer. This is just the appetizer for the unwind that is about to come. I think this is what people should be really afraid of, and I think this is the next leg of this that we will see.

Whether this happens in two weeks or whether this happens over two years, I don’t know. But I strongly believe this will come to pass. And it will be quite disorderly and ugly.

CTAs and RP funds got hammered by the selloff, as the index below shows, but they're still a danger as both algorithms and their human handlers have grown accustomed to dip buying at every turn.


Cole explained in an Artemis Capital letter published in October the dangers that posed by this implicit exposure to the short vol trade - and the probably that a jump in the VIX could translate into a broad market selloff - a classic example of the tail wagging the dog. We included his explanation of how this $2 trillion trade is structured below:

The short-vol trade – if you look at short volatility and you think about what volatility really is – it’s a bet on stability. And when you’re betting on stability, that’s a myriad of different bets.

Part of that is the expectation that markets remain low volatility or low realized volatility. Part of that is short Gammaso there is this implicit short Gamma exposure.

Part of that is a bet that correlations remain stable. Or that different market relationships remain anti-correlated with one another. Or that implied correlations are dropping. Or realized correlations are dropping.

And the other aspect of the short-volatility bet is that interest rates remain low or go lower.

So if we look at each of these different factors, these are the risk exposures that you will have when you own a portfolio of short options. And, if you own a portfolio of short options you are short Vega, you’re short Gamma, you’re short correlation, you’re short interest rates.

What we’ve seen now with this short-vol trade, explicitly and implicitly, is that various financial engineering strategies out there that have become dominant in the marketplace – we’re talking about the largest hedge funds in the world employ these strategies – that are just replicating the exposures of a short-options portfolio.

And of course the VIX trade gets a lot of attention, but it’s the smallest portion of the short-vol trade. This is what we call explicitly shorting volatility. This is where you’re literally going out and you’re shorting an option. Or you’re shorting a volatility future.

But in the VIX space, that’s only about $5 billion worth of short exposure. You have about $8 billion of vol-selling funds, according to Bloomberg. And then about $45 billion (estimated) in pension over-writing strategies, these short-port or short-call strategies the pensions are doing.

So, in total, there’s about $60 billion of explicit short volatility. Which is big. But that’s not the most concerning aspect.

The bigger aspect is this $1.4 trillion in implicit short volatility strategies. These are replicating the exposures of a portfolio of short options, even though they may not be directly selling derivatives or directly selling optionality.

Both retail investors and institutions were hit hard by the events last week. but instead of bracing for more turmoil, reasoning that this explosion could be a symptom of a much more dangerous systemic risk, many chose to listen to the incoherent rantings of a certain CNBC personality, and have mindlessly bought the dip once again...

In stocks...

And in Inverse VIX products...

To them we remember Chris Cole's parting words: "it will be quite disorderly and ugly."

* * *

Cole's interview begins about an hour into the episode:


Laowei Gweilo Ban KKiller Sun, 02/11/2018 - 23:38 Permalink

problem with the OP's thesis is that it just assume short-vol positions sell of all equities and debt.

thing is, they still need rotate into something. they're going to rotate in search of value and book value, like the BofA analyst (who also called the 'Volmageddon' argues).

big difference here with 08 is that it's not just an unwind but a rotation. most short-vol positions INNATELY are based on equity positions of some sort. that's complete different than 08 when they're had to unwind BOOK VALUE (the bad debt) here the risk in in the positions themselves, not the equities that the positions are taking themselves in.

problem with the funds positions rather than before it was problems with the banks that are part of the positions. ultimately these funds are MANDATED to still look for equity alpha of some sort. 

again, that's why the BofA 'volmaggedon' report expected a rotation into small caps, book value, RUSSEL 2000 instead of the SP500

In reply to by Ban KKiller

MaxThrust lloll Sun, 02/11/2018 - 20:51 Permalink

"Obviously, they're getting us ready for what they've planned."

Whether it's planned or not has no bearing on my predicament.

My plan was to own no investments at all. (I've been burned before)

What happens next only affects me if it drives the price of gold lower, then I can buy some more.

In reply to by lloll

InnVestuhrr Sun, 02/11/2018 - 18:56 Permalink

At the peak of my studies in applied mathematics, I was solving systems of non-linear partial differential equations for heat transfer, vibration, electromagnetic radiation, gravitational spaces, etc, ie some really complex stuff,


I *CANNOT* understand *ANY* of this bizzarro-universe volatility-gamma-blah-blah derivative shit.

I think that the exchanges should BAN IT ALL and the people who want to trade it should be expelled.


hedgeless_horseman InnVestuhrr Sun, 02/11/2018 - 19:05 Permalink


I think that the exchanges should BAN IT ALL and the people who want to trade it should be expelled.


Banning products would not help, because traditional market participants and the things they do or don't trade are not the problem. 

Caveat emptor and let supply and demand work its magic.

The problems are Central Bank interventions and bail outs with unlimited money from thin air.   

Stupid should hurt.

If you want to ban something, then ban moral hazard.

In reply to by InnVestuhrr

overbet GatorMcClusky Sun, 02/11/2018 - 19:43 Permalink

Or paraphrasing Putin, countries that have longer term leaders have an advantage over places like the US where theyre decisions are short sighted. He can made strategic decisions looking out 30-50 years while in the US we have 8 years max which limits the Presidents outlook. By the time 30-50 year mark rolls around that President's decisions will have long been forgotten as will his responsibility for the consequences. 

In reply to by GatorMcClusky

LibertarianX InnVestuhrr Sun, 02/11/2018 - 20:41 Permalink

Innvestuhrr… for what it’s worth


Short Gamma strategies mean short optionality

Ie: selling options, puts, calls, vanilla or embedded in other products, digital options or structured notes…

Nb: Delta is the change in option value for a given change in the price of the underlying ‘asset’.

Gamma is the 2nd derivative with respect to price, ie: the change in Delta for a given change in price of the underlying ‘asset’.

For market risk, long gamma is always a risk reducing strategy, ie: as the price of the underlying increases, your option delta will increase, and as the price of the underlying decreases, your option delta will decrease. >> Good for VaR (value at risk)

Short Gamma is the opposite, it’s a bet against volatility and when the price of the underlying increases your delta will get less long if you were long delta, or shorter if you were short delta. When the underlying price decreases your delta will get longer if your were already long and if you were short, your short delta position will reduce. ie: >> BAD for VaR

Of course in all of this we should understand which ‘underlying asset’ has the short gamma strategy… is the underlying ‘asset’ we are talking about here the stock prices / indices… or is the underlying ‘asset’ volatility itself…? Tbh… I have not read / listened to this to be sure what they are talking about exactly.

I do know stupidly low risk / return levels set by the central banks has driven many to selling optionality to try to find some extra ‘yield’ in the markets and I believe this means selling optionality on stocks and also on vol, ie: vol of vol becomes important

I believe there are many funds that buy structured notes with embedded derivatives, because they are allowed to buy bonds / notes but not derivatives… The market has been believing in the central bank 'put', so banks have been selling clients products with short gamma strategies embedded in the notes…

The destruction in value will be there, but the realisation of the losses may not be immediate as the accounting treatment for such notes may be allowed to be accrual as opposed to mark-to-market - depending on the entity holding the notes ( disclaimer... i'm not an accountant and accounting rules may have moved on since I last looked)

Digital strategies would have likely been killed in the big moves we’ve seen recently, whilst non digital may still have a chance of coming back… depending on where we go from here…

You are right, the market is overly complicated, and stupid risk return levels in the markets encourage excessive risk taking, however Hedgeless horseman is also right… moral hazard is a bigger problem… and I would add, so is the underlying ‘money’ which is used...



In reply to by InnVestuhrr

InnVestuhrr LibertarianX Sun, 02/11/2018 - 21:41 Permalink

Thank you for the excellent explanation.

I earned financial independence from creating real tech products and services that people chose to buy, reaping the reward in the value of my stock options (ie REAL stuff), and in 40 years of investing I have earned another fortune investing in only bonds, credit, etc (ie REAL stuff).

I still do not see the benefit to free-enterprise capitalism and stable rational capital markets from all of these complex obscure derivative and derivative of derivatives pseudo-products - they should be confined to casinos and gambling web sites, NOT capital markets exchanges.

In reply to by LibertarianX

RawPawg Sun, 02/11/2018 - 18:56 Permalink

I've noticed,every time somebody gets the credit for "making the call"

they are always never right for making their next prediction come true

Byrond Sun, 02/11/2018 - 19:09 Permalink

People aren't as smart as they think they are. That's why what we think "works" oftentime breaks or malfuntions. And it never really funtioned as intended. Is it illusion? Is it fantasy? Is it a pile if junk? Yes, yes, and yes.

Giant Meteor Byrond Sun, 02/11/2018 - 19:20 Permalink

"Bohemian Rhapsody"

Is this the real life?
Is this just fantasy?
Caught in a landslide,
No escape from reality.

Open your eyes,
Look up to the skies and see,
I'm just a poor boy, I need no sympathy,
Because I'm easy come, easy go,
Little high, little low,
Any way the wind blows doesn't really matter to me, to me

Anyway, your comment reminded me of this ..

In reply to by Byrond

NEOSERF Sun, 02/11/2018 - 19:29 Permalink

If all the Phds that had headed to Wall St. over the last 20 years had instead headed to NASA, we'd be building teepees on Mars by now.

Dangerclose Sun, 02/11/2018 - 19:33 Permalink

Well guys its that time of year again....time to short and bag DB again. I think I'm going to get her this time. That bitch is going to zero this year.

Pumpkin Sun, 02/11/2018 - 19:57 Permalink

I have no doubt they are going to yank the carpet on Trump.  I hope he is smart enough not to waste a crisis, and re-organizes the banking scheme as it is a threat to national security. 

HenryHall Mon, 02/12/2018 - 09:00 Permalink

I read in sevpolitforum that the central Bank of Russia has actually been increasing its holdings of US Treasury obligations since November 2017. By roughly 700million out of 1.4 Trillion. WTF? They understand what is going on so why on earth are they doing this?

Unless Russia is somehow in the secret pay of the US.