Many market agents seem vexed by the VIX. Their recent lessons include a dramatic spiking of volatility, the reactionary pricing of an exchange-traded note (ETN), some forced liquidation, and a blisteringly fast correction in stock prices. The average stock dropped 14% in only a few weeks. Everyone following the investment markets in the US knows the headlines, so we won’t repeat more of them here.
I had a conversation about these events with Jon Ferro and Gina Martin Adams on Bloomberg TV on February 12. On the set with us was Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors. The VIX was on our minds.
Pravit was kind enough to allow us to quote his work and views:
• “The wipeout of the short VIX ETPs should lead to lower vol-of-vol and more stability in the VIX futures market.
• “Significantly smaller VIX rebalance should lead to lower realized vol in VIX futures and lower implied vol in VIX options.
• “A dynamic source of ‘vol supply’ may have disappeared as previous XIV/SVXY investors may no longer be as keen to sell vol.
• “The blowup in VIX products was largely localized to VIX, with a little spillover into FX, rates, or commodity volatility.”
Pravit discussed the mechanical details with me off camera and described them in his Bloomberg TV interview with Jon. Here is his outlook for the post-VIX crash results:
“With the short VIX ETPs all but wiped out, a major source of instability and ‘blowup risk’ in the VIX futures market has disappeared. The short VIX ETPs were exacerbating moves in VIX futures through their daily ‘rebalance’ trading – buying VIX futures on days when VIX was up, and vice versa. Since the VIX ETPs had to buy increasingly many VIX futures as VIX rose, this sent them into a vicious cycle where they pushed vol up, in turn needing to buy even more – causing the ‘VIX blowup’ that we have predicted in many earlier notes. While other levered ETPs continue to exist, the size of this potential rebalance is significantly smaller after the destruction of XIV and SVXY…. On a +4 point move in VIX futures, the ETPs had to buy over 140,000 VIX futures on close. After the blowup, that number has shrunk to a mere 20,000 – back to early 2013 levels.”
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