Let me preface this by saying that when I contend I’ve been “making this argument for years”, I mean that in the most literal sense possible here.
Financial pundits, commentators, analysts and bloggers are fond of reminding you about things they’ve “said” in the past and those reminders always come after something has played out “exactly like” they “said” it would. Of course you rarely hear anyone admit that the opposite turned out to be true. That is, no one ever starts a post/article/TV cameo with this: “In a turn of events that represents the exact opposite of what we’ve been saying…”
I’m as guilty of this as anyone. I habitually point to things I was right about and rarely make a big deal out of it when I was wrong and I also regularly employ the old “I was right even though I wasn’t exactly right” trick.
But as noted in the first sentence above, there is one thing I was absolutely sure of and that’s this: retail investors should be literally banned from trading short vol. vehicles.
Of course that warning accompanied my other warnings about the extent to which those vehicles would eventually blow up and when they did, they would turbocharge a vol. spike, but that warning was just theoretical. I wasn’t sure it would happen. The fact that it did makes me “right”, I guess, but I wasn’t absolutely positive that things would eventually go as wrong as they did.
What I was absolutely sure of, however, was that retail investors have no business shorting vol. with ETPs. That’s insane and it should never have been allowed in the first place. I was pounding the table on disallowing retail investors from using those things from the first month I started this site. The reason I was so sure of that is because irrespective of whether those products ultimately imploded with consequences for the broader market, the bottom line is that the vast majority of people trading them don’t understand what it is they are actually doing and so, those people shouldn’t have access to them. That’s common sense.
And because it’s common sense, I knew with absolute certainty that eventually – even if it took ten fucking years – retail investors would be banned from trading them.
If it was possible to be more sure than sure, well then I was sure-er-er that retail investors would be banned from trading them after Monday and I said as much in a piece for Dealbreaker. Here’s the quote:
Whatever the case, now everyone suddenly understands that there’s a limit when it comes to how much market democratization is desirable. As pretentious as it might sound, retail investors have no business whatsoever explicitly shorting volatility. That was (always) absurd on its face.
The bottom line is that the proliferation of short vol. products was an example of financial market democratization gone too far. There are certain things you do not want the guy in charge of stocking the shelves at your local big box retailer doing, and it turns out that shorting volatility is one of those things.
Who knew trading VIX futures wasn’t as simple as making the cigarette break schedule at Walmart? Apparently not regulators.
Some readers took exception to that which is nothing new. I’ve been getting hate mail for making that argument for going on 10 months. Here’s one particularly hilarious comment from a reader (and you can attribute the misspellings to the commenter as this is copy/pasted verbatim):
what a smarmy cunt this heisenberg. evidently he only respects the ivy league Deucebags who go through the proper channels and jump through the proper hoops before destroying the markets, the country and the world
Well guess what? This (via Bloomberg):
Better late than never.
Three days after the implosion of an exchange-traded note betting on low volatility, Fidelity Investments said it had moved to protect investors from these products.
The fund giant is halting customer purchases of three volatility-focused exchange traded funds, Robert Beauregard, a company spokesman, said in an email. They are: ProShares Short VIX Short-Term Futures (SVXY), VelocityShares Daily Inverse VIX Short-Term ETN (XIV), and the VelocityShares Daily Inverse VIX Medium Term ETN (ZIV).
The ban started Feb. 6, Beauregard said. The firm didn’t issue the news publicly until Friday. “We are allowing customers to sell out of existing positions,” he said.
Representatives for TD Ameritrade Holding Corp. and Charles Schwab Corp. said Friday that customers can still trade SVXY. Ameritrade, however, is holding a 100 percent margin requirement for those purchases, spokeswoman Kim Hillyer said.
Boom. you morons need to be protected from yourselves and if you still aren’t sure why, just read “Morons Massacred As Short Vol. Double Down Goes Horribly Wrong” and “Seth Golden Doubles Down After XIV Blowup, Bets $600,000 VIX Will Fall.”
Meanwhile, Bloomberg has actually put in a feature that is basically a “save-you-from-yourself-o-meter”. Here it is:
And that dovetails nicely with another long-standing argument of mine which is that eventually, other ETFs are going to blow up too. You see how JNK only gets a “1” rating on the risk score? Yeah, well it should probably be more “red light” than “yellow light” and if this selloff starts to spill over into credit, you’re going to find out what “liquidity mismatch” means.
In any event, the point is the same as it ever was, so I’ll just repeat it: we have reached the limit beyond which more market democratization is not desirable. It’s worse than diminishing returns. At this point, the further democratization of markets will do nothing but embed more systemic risk and from that will spring more events like Monday and all the (literal) “diminishing returns” that come with them.