Destruction of VIX-Linked Products May Help Volatility NormalizeBy
The market frenzy that put an unprecedented jolt in volatility measures has claimed its first victims. That might be just the sedative the market needed, options strategists say.
While it’s of little consolation to anyone wiped out by the rout in exchange-traded products that move inversely to the Cboe Volatility Index, the demise of so-called short volatility products forced a mechanical rebalancing so big that it should mitigate future swings, according to Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors.
Products like the now-shuttered VelocityShares Daily Inverse VIX Short-Term ETN (ticker XIV) and the ProShares Short VIX Short-Term Futures ETF (ticker SVXY), which survives to fight another day -- two products that short VIX futures -- were forced to buy roughly 200,000 futures contracts after the close on Monday to rebalance their exposure, MRA said.
Those purchases contributed to the massive spike in VIX futures, and the related plunge in the inverse products, during after-hours trading Monday. Now that the two biggest buyers have been cut down, they no longer have the heft to influence the VIX futures market going forward.
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“From a market risk standpoint, XIV and SVXY have already covered 96 percent of their risk and essentially no longer have any market impact on VIX futures,” Chintawongvanich wrote. “This will not trigger any significant buying of VIX futures, as that happened yesterday.”
To be sure, it’d be premature to say the fallout from the low-vol trade’s blowup is over. These funds only substantially reduce one channel through which volatility could be bid up in a disorderly fashion, but the trade goes far beyond these exchange-traded products. Given the unknown extent of market dislocations and potential for forced selling, there’s no reason implied equity volatility can’t stay elevated or go higher still.
For Peter Tchir, head of macro strategy at Academy Securities Inc., the decimation and demise of these products removes a potential market overhang that should help foster a retreat in the VIX -- albeit, with choppy seas ahead.
“I think near term we will recede to a level commensurate with current level of stress and hedging needs. First guess is under 20,” he said. “It also means that we should see higher average levels of volatility. Where VIX in the low teens is the norm, rather than threatening to break to new record lows.”