VIX ETPs, The Ticking Time Bomb That Could Unleash Volatility

9 בפבר׳ 2018

These fairly new ETPs, such as UVXY, VXX, SVXY, etc. will likely lead to volatility buying in which we've never seen before. People will be using these ETFs to hedge the risk of a larger stock market correction happening, leading to a continuation of the exponential increase in volume that these products have seen since their inception. This exponential increase in volume will lead to these ETFs holding the majority of VIX short-term futures. When these funds are forced to rebalance blindly to follow their prospectus, it will lead to them placing orders at settlement for a number of VIX contracts that may be higher than the daily volume of contracts traded that day. This will lead to massive slippage in the futures market, causing incredible price swings in both directions. Because these ETPs are forced to buy when price of VIX futures goes up, and sell when the price of VIX futures goes down, to maintain a balanced portfolio of 2x, 1x, or -1x respectively. It will lead to a positive AND negative feedback loop as these funds buy or sell futures based on their NAV readjusting and push the price of futures up or down because of lack of liquidity, which makes their NAV readjust higher or lower, which forces the funds to buy or sell more futures, which pushes the price of futures up or down, which pushes their NAV up or down, which forces the funds to buy or sell more futures etc. Once the liquidity risk of the long volatility ETPs becomes extremely significant, like we have just recently saw with the short volatility products (XIV, SVXY, etc.), then the liquidity in the futures market will not be able to support these products and it will cause massive and insane slippage like we've never seen before.

These products did not exist during the last recession, and nobody is really sure how they will act in a real recession like 2008, especially now that their volume is exponentially higher than it was at inception, and could likely continue that trend of increasing for quite sometime, especially if a larger stock market correction occurs, and more investors look to these long volatility products to hedge their risk or make a profit while almost everything else is red. Many are claiming that because some of these ETPs had been shorting volatility on this run up, they had been helping to suppress volatility, which helped to boost the stock market. Now many are quick to blame these products for being the "cause" of the crash this week by increasing volatility. I think that the real truth here is that they did help suppress volatility on the way up, because they sell volatility when volatility goes down, and we've had the lowest volatility in the US since 1964, and as volatility increases, whether it happens now or in the future, these ETPs will help volatility to be unleashed like we've never seen before, because they will buying volatility en masse as volatility increases. These ETPs are not the only cause of volatility, but they will likely be a major factor in helping to create more massive price swings in the VIX than we've ever seen before, which will either unleash or suppress volatility, depending on which way the trend is going.

The most important part is that the long volatility ETPs such as UVXY and VXX, could experience an "acceleration event" like XIV did, but because they are long VIX instead of short, like XIV, this could lead to a massive increase in the NAV of these Long VIX ETPs, potentially overnight, as these Long VIX ETPs become larger and the liquidity risk in the VIX futures market becomes far more significant. While it's not quite clear that these ETPs have reached critical mass, they will likely continue to increase in volume very quickly, particularly if this stock market correction becomes larger and more investors look to VIX ETPs as a way to hedge their risk or make a quick profit. This means there is a ticking time bomb in the volatility market waiting to explode.

2 בדצמ׳ 2021

הערה

Might be time to dust this old idea off.

Volatility is likely going to increase massively during lockdown. If the crowd rushes into long volatility products because of lockdowns, it could cause a massive increase in volatility.

UVXY under normal conditions could go to 150. If we see the long volatility trade being very popular and long volatility ETFs gain a large market share of the underlying VIX futures markets, then we could see a positive feedback loop, like what I described almost 4 years ago, that pushes UVXY to significantly higher prices.