Heisenberg Report

Short Vol. Is One Big Momentum Trade

Feedback loops, dammit.

Rapid mean reversion from transient vol. spikes has become a defining feature of this market. There’s been no shortage of discussion regarding this dynamic and one of the best ways to see it is simply to look at VVIX / VIX which remains – how can we put this nicely? – “elevated”:

As BofAML put it a couple of months ago, “the frequent occurrence of sharp, short-lived shocks justifies a high vol of vol.”


Part and parcel of the rapid mean reversion dynamic is the presence of VIX ETPs and more generally, the proliferation of the short vol. trade which benefits from the transparent relationship central banks maintain with markets.

The two-way communication channel that allows markets to be a co-author of the policy script makes it impossible for anyone to form a long-term view and thus optimizes the prevailing dynamic.

Well, Deutsche Bank is out with a few new bullet points on this and as usual, it’s worth noting if for no other reason that to keep a running tally of how this dynamic is being more deeply embedded in markets by the month.

As the bank notes, we’ve seen this (i.e. rapid mean reversion) before during periods of low vol., but “there have been many more instances with increases in implied vol followed by quick reversals since 2013 (high volatility of volatility), even compared to [similar] low implied volatility periods.”

One thing to note about the chart in the right pane is that the vol. spikes from 2013-present haven’t been very large, thus helping them revert quickly. Also ensuring a rapid reversion are everyone’s favorite market doomsday vehicles. To wit, from Deutsche:

The growing popularity of short vol strategies expressed either through the VIX ETP complex or delta-hedged options has tended to exacerbate the original spike making what may have been smaller increases in volatility more pronounced. However, these revert quickly when there is no sustained follow through to higher levels of volatility, as these same short vol participants re-engage to sell volatility at higher levels.

Right. So what could finally break the spell? Well, that’s the ironic thing about this whole ridiculous trade. The only thing that can break the spell is “a longer period of steadily increasing implieds.” To understand why that isn’t likely, see everything said above. And around we go.

Bottom line from DB: “Short volatility has behaved like a momentum trade.”