Listen, Bloomberg contributor Cameron Crise is a “swashbuckling,” “risk-taking,” pirate of a macro trader.
We’ve established that in previous posts, including the hilarious “‘Swashbuckling’ Pirate: It’s Your Fault That Macro Fund Managers Suck At Their Jobs.”
We like to have a little fun at Cameron’s expense, but it’s good natured and besides, he’s the one who implicitly referred to himself as a “risk taker” and a “swashbuckler.”
Well, Cameron is out on Friday weighing in on the same thing everyone else is weighing in on. You guessed it: low vol.
We’re not sure there’s anything “new” (per se) in what you’ll read below, but there are a couple of things worth noting.
First, Crise says that “the mean-reverting nature of volatility means that it’s inevitable that vols will eventually rise.”
That’s true (or at least it should be true), but don’t forget that in a world governed by central bank liquidity, the idea of “mean reversion” has actually been flipped on its head. “Mean reversion” now means “rapid collapse of vol. after a spike,” as BofAML so poignantly illustrated in the following chart which has become something of a mainstay in this whole debate:
Additionally, Crise uses the “pennies/steamroller” analogy that’s become ubiquitous and although that analogy is, by virtue of its ubiquity, kind of worn out, we would encourage you to read our post on it because it’s by now clear that the retail crowd doesn’t understand the danger inherent in making a side career out of being a vol. seller via VIX ETPs.
Finally, Crise notes that low vol. periods tend to persist, something Goldman (and others) has illustrated and discussed ad nauseam. Here are a couple of visuals:
Now here’s Crise’s latest followed by one last set of charts…
The recent low-volatility trading environment has been a difficult one for directional traders. Vol-sellers, on the other hand, have had a nice run as implied volatility across many assets has sunk towards record lows. The mean-reverting nature of volatility means that it’s inevitable that vols will eventually rise. History suggests, however, that volatility can remain low for longer than crisis hunters can remain solvent.
- There are few things more irritating to a macro trader than trying to scratch out directional returns in a static market as “mindless” vol sellers garner easy profits through a willingness to ignore risk.
- In some quarters this is known as “picking up pennies in front of the steamroller,” as such strategies generate small, consistent returns every day — until they get flattened.
- Periods of rising volatility are usually good for macro traders, not only because of the emergence of trends but also because there is often a fundamental mispricing that gets corrected.
- Unfortunately, this makes it tempting to see a crisis or “volatility episode” behind every curtain. Instead of performing a rational analysis of fundamental and market conditions, traders sometimes conflate their desired outcome with their expected outcome. Call it wishcasting as opposed to forecasting.
- The reality is that low volatility environments tend to endure for an extended period, often as global growth is accelerating…as it is now. One multi-asset implied volatility measure is currently 1.25 standard deviations below its three- year average. History suggests that it probably won’t go much lower, but also that it can remain below average for months, quarters, or even years.
- Thus, while it’s axiomatic that vol will be higher at some point in the future than it is today, it’s far from clear that this need happen any time soon. Perhaps central bank policy tightening could be a catalyst — but the reality is we are probably several years away from global monetary conditions actually becoming restrictive.
- “Cheap convexity” –strategies that lose less as price moves against them and makes more as price goes with them –is one of the holy grails of macro trading.
- Unfortunately, buying the VIX or the MOVE index doesn’t necessarily qualify. An important rule of option trading is that just because vols are low doesn’t mean they’re cheap. Eventually, that steamroller will come. For now it makes little sense to preempt it.
Oh, and don’t forgot what Goldman said late last month: “Low volatility periods do not have to end in tears, but they often do“…