Sunday, August 30, 2015

Ticking Time Bomb: Volatility Explosion

It's too late to hedge en masse. Another event like Monday will cause (options) volatility to explode. Selling will beget selling as programmatic algorithms "derisk" and the unhedged shit their pants...

"16/16 times historically since 1950 when the market traded in a 6%+ range that ended "flat", the market was extremely volatile the following week. Minimum range 3%, maximum 10%."

Nine times ended up on the following week, 7 times ending lower. However, the majority of large swings in both directions were during bear markets.

Last week ended with a "hammer" which is usually bullish.

However, here is a hammer week that was not bullish, blue box:


Selling fire insurance during an inferno, is a bad idea. Shorting volatility - the dominant Wall Street strategy of the past six years, will lead to history's biggest short squeeze...

"What, me hedge?"
Six years of non-stop levitation has conditioned bulls to sell volatility, the options-based equivalent of buying the dip...
Index put/call ratio

Last week's Brown Swan event has now made it too expensive to hedge...

As we know, most participants were not hedged in the first place as we saw from the massive VIX spike. Nevertheless, at these levels, everyone on Wall Street generally sells volatility, under the assumption of a quick return to normal. In other words they spent the week monetizing their hedges and otherwise shorting volatility. 

Unfortunately, when momentum reverses as it has this week, then volatility increases. The longer volatility remains elevated the more it will pressure those who are short volatility (risk). 

Momentum reversal visualized...

Put it another way, for six years, Skynet was feeding on bears by crushing volatility and making options bets worthless. In the new high volatility environment, bulls using the same volatility selling strategies that worked for six years will be crushed by Skynet using the same type of feedback loop: High volatility will lead to selling and higher volatility.

It would be the mother of all short squeezes with everyone on the same side of the boat - short volatility.  

ZH: August 28, 2015
Volatility shorts getting crushed due to VIX backwardation 

Backwardation Visualized (VIX/VXV) (Spot/3 month):

All of this is just a summary of what the prescient quantitative analyst said yesterday:

ZH: Aug. 27, 2015
This week's selling will lead to more selling

In other words Wall Street's overpaid geniuses have all converged on the exact same momentum strategies - buy when the market is rising for six years straight, and sell when it's falling.

And collect a fat bonus until it all implodes with extreme dislocation. 


Another day like Monday, which is inevitable, due to the feedback loop of higher volatility forcing programmed selling - will not get bought, it will get sold, amid an explosion in options vol.