Heisenberg Report

The ‘Doom Loop’: How VIX ETPs Exacerbated Last Week’s Vol. Spike

So last week the VIX spiked and investors (if that’s what you want to call them) were quick to cash in long vol. positions and put on new shorts, a bet that the low vol. regime will reassert itself.

You can see that clearly in the SVXY and UVXY flows through Monday (more here):

Implicitly, that suggests that the ETP vega to buy (which sat at roughly $100 million headed into the vol. spike) would have moved sharply lower on a rebalance and then spiked again on inflows.

Sure enough, Deutsche Bank is out confirming just that in a new note. Here are some excerpts…

Via Deutsche Bank

VIX ETPs likely exacerbated the move in vol both ways over the last week. VIX ETP providers bought almost $90 million of vega following the ~1.5% down move in the SPX last week and the concurrent 3 vol move in the weighted average VIX future, likely pushing vol levels even higher on Thursday and Friday.

After ETP providers rebalanced, vega to buy on a further 5-vol spike fell sharply last Thursday, before rebounding quickly early this week. We also observed providers selling close to ~30m vega on Monday, possibly exacerbating the move lower.

The combination of low VIX futures levels, large short ETPs, and large levered ETPs leaves ~$100mm vega to buy on a hypothetical 5-vol spike in the VIX futures curve; this is roughly 35% of the 2-month average daily 1st/2nd/3rd VIX futures volume.

Implied vol should continue to outperform on an SPX sell-off. The right-hand chart shows that the weighted average VIX future moved slightly more than what has been observed on an SPX move of a similar size. The VIX future shock on a percentage basis was even larger, because it happened when the futures were trading near all time lows. This caused the impact to the ETPs to be much greater.

Translation: VIX ETPs did indeed exacerbate last week’s vol. spike as levered and inverse vehicles rebalanced although we didn’t quite hit the proverbial “tipping point.”

They also likely played a role in the sharp snap back earlier this week.

The takeaway (and this is a point I’ve tried to make to quite a few people who are day trading these things) is that far from “riding the wave” or “playing the BTFD dynamic”, the people trading these ETPs are actually creating the wave/dynamic.

That is all kinds of precarious for all kinds of reasons that should be obvious to anyone with any sense.

Here is Deutsche’s updated feedback loop dashboard:

I’ll leave you with a bit more from Deutsche on the flows.

Short VIX ETPs see large “sell-the-vol-spike” inflows. On Monday we saw a decrease in the 2x long ETPs shares due to redemptions following the increase in vol. However, there have been very large inflows into the short VIX ETPs (mostly in SVXY), following last week’s selloff. These inflows and the quick retrace of implied vol levels mean that vega to buy on a spike has already jumped back to levels from just before the vol spike last week.

Vega outstanding on the VIX ETP complex is close to flat now following increases in the short vol ETPs and some outflows from the long vol ETPs. This is similar to situations we’ve see during prior spikes in volatility (Oct 2014, Sep/Oct 2015, and Jan/Feb 2016)