Blink and you missed it.
For about a week, market participants showed some interest in hedging again as dialed-up exposure was forced to confront a no-longer-disregardable re-pricing across the US rates complex and the specter of state-on-state conflict between Israel and Iran. Vol expanded and skew steepened off extreme flats as demand for downside outstripped short vol flows for the first time in recent memory.
Alas, it proved unsustainable. The muscle memory that dictates equity dips must be bought and vol rips sold prevailed. “We saw peak short vol reflexivity in the US equities options space last week… where the vol-selling universe stayed true to the backtest and smashed rich levels” in everything, Nomura’s Charlie McElligott wrote Monday.
The figures above speak for themselves. The annotations (the arrows) show escalating tension (red) and a rapid de-stressing (green).
McElligott cited “overwhelming” vol supply flows as well as the vol-dampening effect (through the correlation channel) of earnings-related dispersion.
Meanwhile, vol-of-vol just saw one of its largest nine-session declines in nearly a decade.
“Demand for convexity has collapsed, as both the call- and put- wings were smashed,” Charlie went on.
Bottom line: The perception that the tails had fattened amid the escalating hawkish rates re-repricing, longer-term fiscal concerns and geopolitics gave way yet again to a constructive spin on the incoming data and the Pavlovian response function.
Don’t forget the micro. That played a role too. Microsoft and Alphabet held up “their end of the bargain… which has helped put out a large part of that nascent fire in the vol space,” McElligott added, noting that demand for tails has faded demonstrably.
