How long does a given market theme have to last before it becomes structural?

Put (slightly) different, at what point does a recurring theme become a fixture — an attribute of (modern) market structure?

I can’t answer that question with specificity, but I think it’s fair to suggest the combined vol supply overhang from various and sundry manifestations of VRP-harvesting and what the Wall Street Journal amusingly called “boomer candy,” is now structural.

This discussion can be as nuanced (read: esoteric) as you “need” it to be depending on your audience, but the gist of it’s straightforward: In all cases — i.e, whether it’s selling at-the-money vol in an effort to profit from a self-fulfilling prophecy you’re helping to perpetuate with your own flows, or you’re rolling a covered call to offer hefty payouts to retirees willing to accept an upside cap on an underlying equity portfolio in exchange for what amount to super-sized dividends — it’s vol supply.

The updated figures above give you some context for how this supply overhang’s expanding over time.

All that option-selling (“over”supply) acts as a vol dampener and, as Nomura’s Charlie McElligott wrote in his latest, recapping the all-too-familiar sequencing, the associated flows “stuff dealers on long gamma, contribut[ing] to long periods of tight, compressed daily ranges.”

That, in turn, serves to tamp down realized volatility, which then activates mechanical buying (higher equity exposure) for vol-targeting strats in a fortuitous cycle that can last a very long time.

But we all know nothing lasts forever. “Those extended periods of ‘calm’ then create the inevitable ‘Minsky moments,’ as that same stability… creates the conditions for future instability [by] allowing build-up of leveraged exposure and carry,” Charlie went on.

When stability finally tips over into instability, that’s when you “want to own convexity,” McElligott wrote, in the same note, documenting the popularity of VIX calls, which he described late last month as “the market’s preferred calamity hedge.”

The figures above give you a sense of what this looks like on the dealer side, where market makers have evidenced some difficulty recycling risk in a pinch.

Between that (VIX) call-buying, downside equity crash hedging (e.g., evidenced by elevated SPX put skew) and renewed AUM growth for leveraged short vol ETNs (dun dun dunnnnnnnn), there’s “some real tension in the US equities options space,” Charlie remarked, referencing the dynamics behind the August vol shock and a sequel of sorts which unfolded during the holiday-shortened Labor Day trading week.

I cited the same dynamics while discussing the post-December FOMC tremor, when I noted that the above-mentioned “tension” is perhaps best observed in the outperformance of VIX to spot equities and vol-of-vol to VIX.

Coming quickly full circle, it’s always the same: Vol compresses into a melt-up, which incentives more vol-selling, leading eventually to range compression in spot, which triggers mechanical-buying of equities from vol-control cohorts (i.e., systematics), in what appears to be a virtuous cycle. All too often, though, it’s akin to unstable snow accumulation just waiting on the proverbial skier’s scream.

The tension in the VIX complex makes that scenario more precarious. Although McElligott sees potential for vol-selling flows to resume into a renewed melt-up in January, he pointed, as I did a few weeks back, to nosebleed extremes for VIX beta to spot, and recent episodes during which skew and vol-of-vol were “jack[ed] into ‘pucker’ territory” as dealers and leveraged VIX ETNs “need to buy a lot of vega” in the event of a sharp surge in spot VIX.

If this all sounds like evidence of fragility to you, you’re not wrong, even as many of the “guilty” parties would swear up and down that if anything, their expanding footprint enhances liquidity and otherwise improves market functioning, a contention that’s probably true on most days, but almost never on really bad ones.