Over the weekend, we brought you the latest from Deutsche Bank’s Aleksandar Kocic who on Friday offered his take on what it really means to be a vol. seller.
He also described how it is that a low vol. regime develops and persists. “Volatility declines either when the markets are predictable or when there is no consensus,” he says.
Currently, there’s no consensus. “So, what does one do when no decision can be made?” Kocic asks. His answer: “Well, one waits.”
And if, while one is waiting, central banks continue to suppress vol. with hundreds of billions in liquidity per quarter, well then all the better for the vol. sellers who are effectively selling the time they’re spending waiting. They’re offloading “waiting time” and getting paid for it.
Which brings us to SocGen who, while observing the massive hedge fund equity vol. short, explains that the rationale behind this trade is pretty simple: “it’s made a lot of money.”
Funds are massively short on equity volatility
Hard to escape the news: the VIX has reached extremely low levels recently, flirting with single digits (10.2 on 8 June). Despite the uncertain political outlook, net short positions on the VIX have reached extreme levels as well. Both are depicted in the chart below. A wide range of opposing interpretations have been advanced to explain this remarkable profile. At SG alone clients have been offered two different views; investors can either feel reassured by near-Goldilocks economic assumptions (Alain Bokobza) or be unsettled by investor complacency (Albert Edwards). In short, it is probably impossible to read any future market directional patterns from these positions alone.
As SG’s equity derivates strategist, Vincent Cassot, reminds us, the most obvious reason for these short equity volatility positions is that they have made a lot of money. The basic mechanism is illustrated in the chart below, where we observe an upward slope for VIX future contracts with longer-dated maturities.
Right. But for all the home gamers out there who, thanks to the rampant proliferation of VIX ETNs, now fancy themselves expert futures traders, just remember one last thing from the above-mentioned Aleksandar Kocic:
It is a risky trade.