Over and over again last year, market participants of all shapes and sizes asked the same question: “Why is the VIX so low?”
After a while, it was apparent (to me anyway) that the financial media didn’t actually want to answer the question, because asking it over and over again as though it hadn’t been answered was a good way to generate reader interest on days when there wasn’t any.
This particular “mystery” wasn’t especially difficult to solve. 2022 was defined by the most aggressive Fed hiking cycle in a generation, and while a kind of unthinking, naive assumption might be that such an environment is conducive to hedge demand, you don’t need a hedge for exposure you don’t have. That’s especially true when your cash allocation is historically elevated. To the extent you need a crash hedge, your cash position is your downside protection. When there was demand for hedges, it was actually for upside — that is, under-positioned investors grabbing for calls to avoid missing a rally. So, the “traditional” correlation between vol and spot didn’t necessarily apply. (That wasn’t the only correlation that ended up flipped on its head in 2022.)
Fast forward to… well, to right now, and people are asking the same question about a “too low” VIX. This time, the answer is a bit more nuanced, but regular readers who’ve been following along can probably offer a decent explanation. Hint: It’s option hedging, vol-control buying on a lag following rVol compression, the allure of very high Sharpes for vol-selling pulling in more of the same flows and a mechanical vol-suppressant impulse from offsetting price action associated with idiosyncratic performance around earnings season.
Here’s a quick bullet point version from Nomura’s Charlie McElligott, who on Thursday enumerated five “inputs” to a low VIX:
- We are pinning between the two largest $Gamma strikes into Op-Ex — 4200 and 4150 —with dealers stuffed on (now ATM) optionality, as we rallied up into short strikes in recent weeks, which were not long ago OTM calls which had been sold by overwriters to dealers
- As daily ranges compress via dealer long gamma, plunging US equities realized vol spins off more ‘latent’ vol-suppressing equities buying / demand from the target vol space, now at $18 billion of buying over the past two weeks, $48 billion over the past three months and $73.6 billion over the past six months
- Extreme systematic short vol / short gamma profitability in recent weeks, which then continues fueling the price action via ‘reinforcing’ flows
- Extremely steep SPX term-structure now re-incentivizing systematic roll-down players in VIX
- And, finally, SPX implied correlation cratering as EPS season kicks off, on standard ‘winners’ / ‘losers’ dispersion
“Mystery” solved.
