What Created the Perfect VVIX Storm?

The CBOE VVIX Index (VVIX) explored its highest ever reading on Monday

by Adam Warner

Published on Aug 26, 2015 at 10:09 AM
Updated on Jun 24, 2020 at 10:16 AM

Some notes from the VIX-plosion. A friend of mine who is very familiar with hedge funds sent me this on Monday during the implosion:

"For what it's worth, a lot of what's going on is lack of liquidity (no market makers) and margin calls all over the place. What people forget is that 90% of all hedge fund money is now run by 100 firms. These firms are almost exclusively multi-strategy. Therefore, if they hit their firm-wide loss limit, every strategy needs to reduce exposure regardless of their p/l. That is why you get a correlation of 1.0 across all assets. People still don't get that.

"Also, in large moves like this, you don't get tick by tick margin calls. So after Asia close, you get grossed up on your margin calls, so you sell in Europe. Europe has large losses, so you get grossed up again with another margin call in the US. It is a daisy chain capitulation trade. People think that margin departments can calculate margin calls real time. In reality there is some lag, especially when markets move so fast and they have so many margin calls to make."

I'm pretty sure one of the strategies involves selling all these overpriced CBOE Volatility Index (VIX) calls. Well, formerly overpriced. VIX options trading is a relatively small part of the market, and unlikely to have "caused" the cascade. Variance trading as a whole, though, is pretty big, and there's an awful lot of zero-sum trades where someone is necessarily on the wrong side.

The CBOE VVIX Index (VVIX) is the VIX of VIX; it proxies the volatility of VIX options. And it made quite the move this past week:


150826Warner1


It went from 91 last Wednesday to a high of 212 on Monday, which was its highest reading ever (we've only had VIX options for a decade, so "ever" isn't that long). In other words, it moved similar to VIX. VIX options have huge positive skew, so, thus the speed of the VIX move, combined with the fact that now much higher strike options are at the money, made this the perfect VVIX storm.

I'm sure the actual damage to a VIX call short is pretty bad. But, it's not quite as bad as meets the eye. That's because VIX futures don't actually assume this VIX pop is permanent. Here's how the term structure looked before Tuesday:


150826Warner2


Yes, VIX is always going to 20 in half a year, whether actual VIX now is 12 or 42.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research


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