A consistent, reliable buyer of equities could morph into a seller going forward. And it wouldn’t take much in the way of fireworks to make it happen.

Over the course of 2023, the steady decline in realized vol created a latent bid from the vol control universe, which added exposure as the daily range of spot outcomes compressed.

Since last year’s lows, vol control funds have taken up their exposure by some $160 billion. According to Nomura’s Charlie McElligott, their allocation is now in the 90%ile.

The figure above gives you a sense of the potential for “large selling,” as Charlie put it, and more importantly, of how low the threshold is. Selling could happen on relatively small daily changes.

“Target vol funds have been such a source of persistent equities demand over the past nine months [but] after topping up the allocation… we are now in a place where projected and sustained daily SPX changes of + or – 1% would begin to force de-allocation,” McElligot said.

As the figure shows, Nomura’s estimates suggest that ~1.0% daily moves, if sustained for a week, would trigger more than $11 billion of US equities selling from vol control. Needless to say, that estimate increases dramatically as the hypothetical daily average spot range expands.

In the same Tuesday note, McElligott said that considering the scope of recent systematic and discretionary equities re-positioning, VIX call spreads could make sense. “It wouldn’t take much of a vol move to dictate a substantial equities deleveraging blast that could really kick up the illiquid VIX complex, particularly off of such a low base vol,” he remarked.

Stability breeds instability.