“Volatility’s your exposure toggle.”
You’ve heard that tagline before. It’s one of several attributed to Nomura’s Charlie McElligott, who appeared earlier this week on a hastily-convened, “emergency” episode of Bloomberg’s Odds Lots podcast. Technically, the McElligott chat was for “Lots More,” a kind of Odd Lots spinoff.
Regular readers (and everyone else for that matter) are encouraged to listen to the discussion here. It’s mostly a reiteration of McElligott’s recent notes, but it’s a joy to hear Charlie tell it himself.
His take on recent events is a bit different (or more nuanced, I should say) than what you’ll get from mainstream media accounts. Charlie puts a lot of emphasis on the equities vol regime shift which began several months back, when historically flat skew started to steepen. I won’t go into that at length here. If you’re interested in the backstory, you can peruse “Skew Has A Story To Tell” from April 9.
Coming quickly back to vol as an exposure toggle in modern market structure (incidentally, there’s a very real sense in which McElligott’s toggle adage has been true since time immemorial, and in all contexts, not just those related to trading and markets), the figure below depicts the realized vol spike witnessed over the past week.
As is plain from the visual, one-month rVol is 100%ile on a one-year lookback.
Vol expansions — to say nothing of vol shocks and “freak outs” — have consequences, and as per the “toggle” adage, the read-through of the dramatic spike highlighted in red was de-risking, de-leveraging and de-allocation across the vol control universe.
The figure on the left, below, gives you an idea about the scope and rapidity of that de-allocation in recent sessions. It’s quite significant.
On the right are estimates of vol control re-risking / de-risking for different spot outcome distributions over various windows looking out to three months.
As a quick note, that table was current as of August 7 in the US morning. The numbers won’t be exactly the same today, but for our purposes, the point is that the sheer magnitude of the rVol spike means it’s going to take longer — which is to say a prolonged period of contained daily moves — to trigger a meaningful re-risking impulse from vol control strats.
McElligott’s annotations spell it out: Even if the S&P were to settle into an “unchanged” regime and stay there for two weeks, you’d only get around $15 billion of re-allocation flows. We need a month of contained moves to trigger that latent bid in size.
“Trailing realized vols will remain a local headwind to the ‘pile back in’ upside trade,” Charlie wrote. “It’s going to take close to a month of smaller daily trading ranges to begin feeding into lower rVol to allow for re-allocation following the shock-out.”
Vol expansions have consequences.
This is good info. thanks!
Thank you.
The chart suggests there was around a $125 billion reduction in equity postions. That’s some serious money there.
I’m surprised that the stability/buy again requirements hurdle is so high.
Fun fact: Charlie’s undergraduate degree was in government with a focus on international relations. Dartmouth man. Endorses a diet regimen that has the potential to solve the globe’s overpopulation problem, too, hahaha
Are you suggesting that he is a woke vegetarian dilatant? So much for his thoughts, eh?
If you spent a few seconds researching his diet online, you’d see it’s the exact opposite. And I might be using the word “solve” ironically.
Owlsey Stanley.aka the bear, ended up moving to Australia to be better able to pursue.his meat-only diet.
I still loved him
H-Man, thanks for the link to the podcast. Next week may tell us more about whether vol is settling in or ripping higher. I liked his comments about the carry trade not really having much of an influence in the debacle that happened a few days ago.
Ditto re the podcast link. Also, just want to say I enjoy all posts on McElligott’s views.
CTA funds have more selling to do, per GS. Not giant amounts, but not small – low to mid tens of $BNs I think.
Sounds from McEligott that vol-based funds will not be significant buyers for at least a month.
What major +ve and -ve catalysts in the coming month? NVDA report. Middle East. Macro bad news is bad and I suspect good news could be spun bad, with FOMC in Sept and grown men still begging for flocks of doves.
OTOH, lots of charts at their 200D. And traders who aren’t entirely rules-based will be looking at prices 10-15-20% more attractive than a few weeks ago, on estimates that have held up – reading that 3Q estimates have been trimmed less than normal.
Implies indicies flat to weak for near future?