A top-tier financial web site interviews me at the start of every year. The interviewer typically asks me about specific securities, asset allocation, economic backdrop as well as the impact of events (e.g., central bank monetary policy, mid-term elections, tax reform, etc.)

This year, at the tail end of the interview, I fielded an atypical query. He wanted to know what “market surprise” might occur in 2018 (good or bad) that the financial media are not talking about.

I thought for a brief moment. Then, I answered with the following:

“You have scores of people who are doing nothing more than sticking with the trade that has worked so well for five-plus years, and that’s shorting volatility. Yet risk premia really cannot move much lower…”

“One aberration, one surprise or shockwave to the system, and volatility would soar. People are not prepared for the eventuality. Scores of traders/investors will get scorched by a rapid reversal in volatility pricing…”

Now, everyone’s talking about the violent short-vol unwind. Indeed, many blame the volatility event for the Dow’s 4.6% Monday beating. Even worse, the popular trade’s reversal completely wiped out participants in a matter of hours.

Those who had grown comfortable (and greedy) by holding positions like VelocityShares Daily Inverse VIX Short Term ETN (XIV) rode a runaway train straight off of the tracks. Imagine boarding just two years ago near a price point of 20. Two years later, you prematurely celebrate an astonishing 600% return when XIV hits 140. And then a singular “unforeseen” moment, nearly everything you had invested, including your principal gets eviscerated.

To be clear, I did no predict when the eventuality would occur. Yet the risk-reward of participating in a trade that taxi drivers and Uber drivers were recommending to me? I have seen enough and studied enough over 30 years.

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