So, it turns out that whole VIX ETP rebalance risk was a real thing.
And you know what? The funniest thing about what happened on Monday is definitely not that a bunch of former (and likely future) big box managers got wiped the fuck out leading to what I imagine were some rather awkward moments at dinner tables around the country, but rather the deafening silence from popular Finance Twitter folk who for the past year, have generally dismissed the whole VIX ETP problem as something that was a figment of skeptics’ imagination.
On countless occasions over the last nine months I marveled at how casually FinTwit’s pantheon of notables (and by “notables” I mean that list of handles, some anonymous some not, with between 1,500 and a million followers) summarily dismissed the whole “doom loop” dynamic as something akin to an urban legend.
The reason it was so bizarre to see ostensibly smart people (some of whom actually trade volatility) laugh off the rebalance risk is because that risk was quantifiable. And the banks were quantifying it. As in tracking that shit in real time. So you know, “numbers” and stuff. I guess the idea behind the dismissive attitude was that everyone assumed it was impossible that vol. would spike enough in a single day to start tipping the dominos, or maybe they assumed the market would be able to absorb the flow from levered and inverse VIX ETPs, but whatever those people assumed, they were fucking wrong – and “bigly”.
Fast forward a couple of days and we’ve almost finished carting off the lifeless bodies of the XIV and SVXY crowd and we’ve done our best to hose down the streets so the metallic blood smell doesn’t keep lingering over the U.S. session.
The “good” news is that thanks to the massacre, that VIX ETP rebalance risk which the punditry swore to Christ wasn’t a problem, actually isn’t a problem anymore. In that same kind of way where that festering hornets’ nest in your garage isn’t a problem anymore because you put on a hazmat suit, knocked it down, kicked it out into the front yard, poured kerosene on it, and lit that fucker on fire.
Have a look at this:
As you can see, that’s the vega-to-buy by ETP issuers on a 5-point spike in VIX futs, and “happily” it has collapsed.
The reason “happily” is in scare quotes is because reducing that rebalance risk meant a whole bunch of people getting figuratively doused in kerosene and lit on fire like those fucking annoying wasps in the garage.
“Do I have to worry about VIX ETPs driving another similar volatility spike?”, Goldman imagines you might be wondering, in an amusing post-mortem Q&A piece.
“Not for now, and not likely anytime soon,” the bank dryly writes, answering their own question.
Yes, “not likely anytime soon.” Because as the bank continues, “the large short VIX products were the primary driver of Monday afternoon’s late-day acceleration in the VIX, and with them diminished ($300mm AUM now vs $3.9bln peak AUM), the quantity of VIX futures ETP issuers would have to buy on a further volatility spike is diminished as well.”
So good news to the super-smart VIX traders on Twitter who told you this wasn’t a risk!
They’re right. Now it isn’t a risk.