The Mystery Of The Short Short VIX Trade

I’ve talked a ton about volatility (or, more appropriately, an acute lack therefore) in these pages.

Currently, the VIX is sitting at a 10 handle, plumbing last week’s post-“phenomenal” tax plan depths. And this of course comes on the heels of the 3rd and 5th calmest January in history for average VIX level and realized vol, respectively.

Some of this can plausibly be attributed to the fact that intra-stock correlations have plunged. “Index volatility is a function of not only average single stock volatility, but also of how stocks within S&P 500 are moving with respect to each other – a measure of correlation,” SocGen wrote earlier this month, adding that “when the correlation is low most stocks are moving in different directions [and with] all these individual stock moves there is no clear direction to the overall index, and this in turn dampens down volatility.”

And of course there’s also the simple fact that suppressed realized vol begets low implied vol.

(SocGen)

So with the short vol trade the most crowded in history…

… the logical question is when we’ll start getting some capitulation. According to Bloomberg, we’re finally seeing some speculators investors throwing in the proverbial towel. To wit:

With the financial markets strangely quiet, investors in volatility are finally getting fed up with losses and abandoning their positions.

Barclays Capital’s iPath S&P 500 VIX Short-Term Futures Exchange-Traded Note, which goes by the symbol VXX and is the largest ETN linked to the Chicago Board Options SPX Volatility Index, also known as the VIX, has lost about 16 percent of its assets this year, according to Bloomberg data. Other exchange-traded products that track the VIX also have shrunk as investors give up on an expected surge in fear that never seems to come.

“It looks like investors might be tiring a bit,” said Rocky Fishman, an equity derivatives strategist at Deutsche Bank AG in New York. “In the past, when the VIX was flirting near low levels, people were a bit more optimistic on some type of VIX rebound, so they bought additional shares to maintain their position sizes.

That makes the following chart even more curious than it already was:

(SocGen)

If the VIX ETP longs are capitulating, then why is everyone who’s short the short VIX ETPs still hanging onto losing positions?

Chew on that.