Zero Lessons Learned: Retail Investors Are Again Pouring Money Into Short VIX ETFs

After last Monday’s terminal event for the XIV – which at the time was the second largest inverse VIX ETN, before a the so-called volocaust and the subsequent record VIX eruption, resulted in a 96% NAV loss and subsequent termination “acceleration”…

… one would assume that retail investors – the target audience of volatility ETPs – had learned their lesson and after suffering a near total wipeout, would stop shorting vol and in general, no longer collect pennies in front of steamrollers. One would be wrong.

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But first, a quick reminder oh how various investor classes use VIX-linked products (including options, ETNs and ETFs).

At the top are the institutional traders, virtually all of whom have been forced after a decade of central bank yield and vol suppression to turn massively short-vol, and use the decay in theta as a source of “dividend” income. According to Fasanara Capital, the consolidated value at risk among all explicit and synthetic institutional vol shorters is about $22 trillion. One way of gauging institutional investors’ demand for equity hedges, particularly tail risk hedges, is by looking at put and call open interest on VIX options. The use of VIX options has increased significantly since the Lehman crisis by investors seeking to hedge against equity tail risk, credit exposure or volatility exposure. As JPM confirm, several investor types such as vol targeting (equity or multi asset) funds or risk parity funds are structurally short volatility and “VIX calls provide the most direct and liquid way to hedge their short volatility exposure.”

The JPMorgan chart above shows the VIX put and call open interest, and suggests that after the ratio of calls to puts increased for much of 2017 it reached a high in mid-January. Since then, a rise in put interest has brought the ratio back to its average level since 2014. One explanation is that the recent collapse in equity index volatility to record lows induced demand for protection against a volatility spike. And with such a spike materializing this week, institutional investors appear to have taken profit on some of these hedges this week.