From vixcontango.com :
The Tipping Point Has Arrived
Over the past few months the mainstream financial media – Wall Street Journal, Bloomberg, CNBC – has started a breathless coverage of the short volatility trade. XIV has been the best performing ETF by far over the past 12 months (200%) and year to date (88%) and since it is at the top of the rankings, our reporter friends have tried to outdo each other at figuring out what is going on, how this trade came about, etc.
Of course, it was quickly discovered that the whole thing was started by the Marc Cuban/Goldman Sachs cartel and they have been secretly minting money out of this trade since the mid-80s. I am sure somewhere along the way there was a bailout by Warren Buffet who got a 15% warrant that pays in perpetuity, but they haven’t gotten to that part of the story yet. This trade obviously is quite a bit above the comprehension level of 25 year old reporters who are a couple of years out of college since it involves multiple, very complicated market structures, highly sophisticated financial instruments and a lot of incomprehensible math. If you would believe it, a Wall Street Journal reporter who got assigned to cover this area of finance roughly a year ago, asked me to explain what a “leveraged ETF” is. So a person who is just learning what a leveraged ETFs is doing reporting on the SPX options and futures markets, the VIX options and futures market and the related ETFs. Sure! No wonder, the whole thing was started by Mark Cuban! It is almost an insult that one of the most sophisticated areas of finance is covered by some of the most unsophisticated reporters. After all real reporting is probably way too much work and is not really guaranteed to generate eyeballs. See a story with the key words “Mark Cuban” and “Goldman Sachs” is a guaranteed eyeball generator…
So the untrained and financially illiterate reporters has been breathlessly talking about how the short volatility trade is “overcrowded” simply because it tops the performance rankings. All throughout March and April, I had to read this nonsense and I spent a lot of time debating these erroneous notions on Twitter. In the reporter’s limited understanding, if the XIV is going up, it must be because money is chasing it. After all, that is what happens to real estate, Amazon or any other regular stock. It’s a crazy mania and everybody is doing it! Anybody who understands the short volatility trade, however, understands that the profitability of this trade has nothing to do with the amount of money in the market and everything to do with the magnitude of perceived risks to the market. If market participants are scared a lot about something, there is a lot of money in the trade. If they are not scared, less. The spread in the VIX futures market is what matters. If the spread is wider, the trade will make more money over time and if the spread is thinner, the trade will make less money. If the spread inverts, the trade will lose money. The specific spread in the short volatility trade that matters the most, of course, is the contango of the front two VIX futures since that is what the ETFs track and ETFs provide majority of the exposure in the trade. In this respect, short volatility is not very different from many bond yield spread trades or currency futures spread trades, or oil futures spread trades and their related ETFs but somehow the reporters haven’t quite figured that out yet. So the misinformation campaign continues.
However, here is where the story is starting to get interesting. Even though at the start of the year, there was no noticeable pickup in the AUM of short volatility ETPs, due to the constant pounding on the airwaves, investors have now started looking at the short volatility trade more seriously. Obviously, we have a new short volatility fund and we are constantly talking to various investors big and small and we are doing our part in raising awareness as well, but the media’s constant coverage of this new asset class is undeniably what is starting to move money. So much so that as the VIX hit 3rd lowest reading of all time on Friday at 9.51, we had a tectonic change in volatility positioning.
Net aggregate VIX futures exposure via ETFs finally became negative yesterday!
When the media was breathlessly obsessing over short volatility in March and April, short exposure was about 1 billion dollars – less than Oct and November of 2016. Contrary to the reporting, there was a general lack of interest in the trade. I am on the front lines and I can tell you that people have been avoiding short volatility all year as they have been waiting for a volatility spike to transpire. What was actually happening earlier this year, however, was that money was leaving the long volatility trade. Trump clearly didn’t justify the fears and the World Apocalypse didn’t arrive – instead companies are making money hand over fist in earnings. Investors can stick to their shitty political beliefs only for so long before their pocket starts to hurt so… hedging stopped and the long volatility trade was abandoned. But that is still not the same as a spike in interest in short volatility.
However, since the breathless coverage in March and April was initiated, now we are definitely seeing an increase in short volatility flows. The short volatility ETPs increased AUMs from 1 billion to 1.3 to 1.5 to 1.7 and finally just this last Friday, it crossed the 2 billion mark. Long volatility ETPs have been losing AUM steadily and went from 4 billion at the election to 1.5B on Friday. This puts us in a state of net volatility exposure to the short side for the first time since Aug 2015 – Feb 2016 period (the Dealers Exposure chart below shows delayed data so the latest ETF AUM changes aren’t reflected. Dealers Exposure is very similar to the net ETP exposure since ETP positions are reflected as Dealer Open Interest). And we all know what happened in Aug 2015. Basically, what is happening here is people are staring at this 88% YTD return of XIV and want a piece of the action. And of course, the cavalry is arriving at the scene just as the VIX is hitting all-time lows. Just like in 2014 and 2015, great timing! [eyeroll]
SVXY has gotten an additional $600M in AUM over the last 2 weeks to jump from about $600M to $1.2B. I did mention on Twitter that it has a favorable 60/40 tax status and I immediately had to answer dozens of people on Twitter and in email. Then I did put out a big white paper (Enhancing Portfolios With Short Volatility) a couple of weeks ago as well which has so far gotten roughly 250 downloads. I think that might something to do with the sudden rise of SVXY. Very interestingly now, SVXY is the most popular volatility product as of Friday! VXX is now in second place below 1 billion dollars and XIV in third place with about $700 million. UVXY had a monster dip in AUM on Friday. It appears that a bunch of money moved from UVXY into SVXY on Friday and a bunch of money left VXX. The total AUM is down to 3.7 billion. I guess some folks have decided that it is time to make all the long volatility losses back by shifting to short volatility. [another eyeroll]
You have been warned!