In a nutshell, Skynet is positioned to sell into Options Expiration (Friday) due to last week's melt-up fakeout and the attendant rollover below 2100, leaving an excessive amount of put options exposed to exercise. As these puts move further into the money, options "convexity" requires ever-larger amounts of underlying to be shorted against this exposure. Meaning an accelerating sell-off.
The last time we saw this was during the Flash Crash last August 24th, 2015. And now we know why VVIX skyrocketed yesterday. VVIX is a proxy for convexity aka. second derivative volatility:
"...central banks and option-related flows over the past 2 months were suppressing market realized volatility and contributed to the buildup of leverage in systematic strategies. As a result, Volatility Targeting portfolios and Risk Parity strategies likely run near record historical levels of equity exposure...High levels of equity exposure, currently in the ~90th historical percentile, indicate high market risk posed by a potential increase of market volatility. Equity exposure of Hedge Funds is also above average"
"About ~$1,000Bn of S&P 500 options expire this week. The gamma imbalance turned towards puts yesterday ($9bn per 1% currently), and this will likely push realized volatility higher near term. Post expiry, clients are likely to roll put strikes higher, which will also be supportive of higher volatility. Yesterday’s large move on the VIX indicates short gamma exposure of dealers on VIX products as well."
Gamma Risk visualized:
Skynet is driving this short-covering rally, momentum traders are along for the ride...
Gamma Risk visualized:
Skynet is driving this short-covering rally, momentum traders are along for the ride...
