It’s Just a Flesh Wound – But a Sad Day for Vol Sellers
On January 31 we wrote about the unprecedented levels – for a stock market index that is – the weekly and monthly RSI of the DJIA had reached (see: “Too Much Bubble Love, Likely to Bring Regret” for the astonishing details – provided you still have some capacity for stock market-related astonishment). We will take the opportunity to toot our horn by reminding readers that we highlighted VIX calls of all things as a worthwhile tail risk play. Not only were we right, we were actually kind of double-plus right, with near perfect timing to boot. That doesn’t happen very often, so forgive us for enjoying this brief moment of Zoltar glory.
Sometimes it just works… Zoltar has happy news for that exceedingly rare species, the “long vol” speculator (lately seen to be recovering – the endangered species, we mean).
Most of our readers are probably aware by now that there was a very specific reason behind the VIX intraday spike to more than 50 points in the face of what was not even a 10% correction. One of the most beloved “free money”/ “it’s like taking candy from a baby” trades of the past few years, namely “selling volatility”,blew up rather spectacularly for some traders.
Judging from assorted sob stories that have made the rounds, some people appear to have neglected reading the fine print accompanying leveraged inverse VIX ETNs (or decided to ignore it). These instruments benefit greatly from a declining VIX, but are rather uncomfortable to hold during VIX spikes. ETNs such as the recently unceremoniously expired XIV are liquidated if they lose more than 80% of their value in a single day.
What many people failed to consider was the fact that the VIX is subject to an effect akin to bond convexity – which was incidentally a major reason why we liked VIX calls as a tail risk play. Essentially, the lower the VIX went in absolute terms, the more likely it became that it would one day experience a very large percentage move in a very short time period (such as going up by 100% or more in one day).
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