The short vol trade’s back. Did you hear? You did?! That must mean you’re a regular. (Cue the Cheers theme.)

Or it means you read the latest installment of Bloomberg’s “Big Take,” published on the traditional six-month lag behind whatever “big” it is that’s going on. (I’m just joking, Bloomberg. All it good fun.)

A couple of readers wrote in Monday to ask about the above-linked Bloomberg feature piece, which declares “one of the most infamous trades on Wall Street” back from the dead.

The short vol trade never actually died, of course. “Short vol” is a catch all for any number of trades and strategies ranging from the esoteric to the wholly generic. In mainstream discourse, though, it’s almost always a reference to VIX ETNs and related products popularized during 2017’s short vol bubble, which burst spectacularly on February 5, 2018, Jerome Powell’s first day in the big seat. That day lives in infamy. That was the day the EOD rebalance risk embedded in popular retail vol products manifested in a singularly spectacular shock to the VIX complex.

The trade discussed in Bloomberg’s “Big Take” isn’t the same trade. The products at the heart of the new retail “short vol” trade are buy-write ETFs, which is to say ETFs that’ll deliver capped upside on an underlying stock portfolio (or single stock) with an income overlay from a rolling short call. The idea is to retain exposure to a rally even as you accept a ceiling on that upside in exchange for income.

Who’d be interested in that pitch? Well, an “aging demographic who know they can’t retire on money market returns alone,” as Nomura’s Charlie McElligott put it last year. To the extent some investors don’t believe they can pre-fund their post-career lifestyles with cash income, even when term deposit rates and government money fund yields are the highest in two decades, the marketing gurus at ETF houses are more than willing to offer a “solution.”

The updated figures below, from McElligott, give you an idea of how ETFs have turbocharged AUM growth, and also what the associated flows have meant for vega supply.

Total AUM’s doubled since early 2020, and ETF AUM went from essentially nothing to ~$65 billion. As noted above, this isn’t confined to index-linked products. There are now single-stock versions tied to popular names like Nvidia.

Not to put too fine a point on it, but I really have been over this repeatedly. Three months ago, for example, I published “The Big Impact Of A $60 Billion Options ETF Trend.” That was basically Bloomberg’s March “Big Take” only in December. On January 16, I published “Options-Selling ETF Trend Spreads To Single Stocks,” which detailed the extent to which AUM for single-name income products, most of which only recently came into existence, was rising sharply. And so on.

Credit where it’s due: Bloomberg’s Lu Wang and Justina Lee (both of whom are very capable journalists) did hit all of the important points in their piece, including the notion that if the explosive AUM for derivative income products is “dangerous,” it’s not because the products themselves represent the same sort of risk posed by 2017’s star-crossed VIX ETNs. Rather, it’s because the associated flows tend to suppress volatility, and persistently low vol can be conducive to “bad” behavior, leverage deployment and so on (volatility’s famously “the best policeman”). As Bloomberg put it, “the positions — alongside a stack of less visible short-vol trades by institutional players — are suspected of suppressing stock swings, which invites yet more bets for calm in a feedback loop that could one day reverse.”

In the linked December article, I put it this way: “The associated flows don’t exist in a vacuum. They’re impactful. And increasingly so.” Nomura’s estimates suggest monthly vega supply attributable to derivative income ETFs rose by nearly a third last month versus February of 2023. “Our latest estimates of monthly vol supply from the options selling universe across VRP ETFs, MFs and exotics is now nearly $241 million vega for sale per month so far in 2024, and that’s excluding massive size out of the QIS and buyside / sellside dispersion universe,” McElligott remarked.

That latter point (the QIS and dispersion book bit) is where it gets murky. As Charlie alluded to, the size of the structured products space is unknown, and as Kevin Muir told Bloomberg, the dispersion trade’s just like a lot of RV and arb — it works until it doesn’t. Stock correlation’s low and that’s supporting return dispersion which, despite being about average on a longer-term lookback, is “elevated compared with the low dispersion environment that defined much of the past decade,” as Goldman’s David Kostin put it in his latest. Falling correlations and high (or “elevated”) dispersion can suppress index-level vol, creating an exploitable disparity between surface-level calm and underlying churn. Somewhere in a cookbook there’s a recipe for disaster. The ingredients are RV, leverage and smart people. Long story short, Kevin worries there’s a lot of cookin’ goin’ on in dispersion pods.

The message (or one message, anyway) is that we’re only seeing the tip of the proverbial iceberg here. Whether or not derivative income ETFs are themselves a risk (they’re not), they’re contributing to the self-fulfilling, seemingly perpetual suppression of index-level vol. “The more crowded these short vol strats get, they need to short more to achieve return objectives,” McElligott said last week. “And of course, part of the issue then becomes the pile on, with dealers and market makers getting stuffed on the gamma, so they then too have to sell any vol they can find [to avoid] bleeding to death owning these melting options — vol smash feedback loop unlocked.”

That loop tends to sow the seeds of its own demise one way or another, and almost as sure as night follows day. But bear in mind: You do need a vol expansion catalyst — a shock of some kind —  to break the stupor.