Last Thursday morning, just as the VIX was soaring on North Korea nuclear war fears in a historic move from single digits to ultimately peak just above 17 before retracing virtually all of the move in the coming days, we reminded readers that "As VIX Explodes, A Painful Warning: The Vega Of VIX ETFs Has Never Been Higher", referring to a recent observation by JPMorgan that the outstanding vega of VIX related ETF was a record high.
This is how JPM described this observation previously: "in Figure 4 which is provided by our Equity Derivatives Strategy team and which uses a more sophisticated calculation to estimate the net vega, i.e. sensitivity to each percentage point change in vol, for the total universe of VIX related ETFs adjusted by their short interest. This vega stands at historical high levels currently." In plain English, what this means is that if VIX spiked, the volume of VIX-related shorts that would have to cover would be practically unmatched, resulting in a feedback loop where the higher VIX spiked, the more shorts would have to cover, and so on.
Now, thanks to Bank of America we have confirmation that this is precisely what happened.
This is what the bank's derivatives expert, Benjamin Bowler, writes in an overnight report:
... the volume in VIX-linked products reached an all-time high on 10-Aug and only modestly declined on the following day. Volume in VIX call and put options (not delta-adjusted) reached a $250M vega. VIX futures also had a record volume day with $850M vega traded in the market with the vast majority of this volume in the front and second month futures. Similarly, volume in long unlevered, long levered, and inverse VIX ETPs reached an alltime high of $830M vega traded, roughly triple the prior month average.
The chart below shows just how insane the record volume of VIX-related volume, through options, futures and ETFs, was in context - no other day has even come close.
Yet while the explosion higher was more or less expected, if perhaps not by millions of vol-sellers many of whom were stopped and/or margined out with major losses, and the associated volume burst was previewed both here and on other financial outlets, perhaps just as remarkable is what happened next.
As Bowler writes, "both the spike in vol and the speed of its retracement were almost unmatched." First, here is the blow by blow of what happened on the way down:
The VIX spiked 44% on Thursday, August 10th amid escalating tension between the US and North Korea. While on an absolute-basis this was the 8th largest 1-day spike, on a VIX-level adjusted basis (as measured by the 30-day trailing average of the VIX level), the move was the second largest of all time as the extreme calm of late abruptly came to an end (Chart 20). Thursday’s surge was surpassed only by the move on 27-Feb-2007, when market calm suddenly evaporated amid investor concern that a slowdown in China was signaling a larger downturn in global growth. Stocks tumbled, and the S&P lost 3.5% that day. Notably, there has been a higher frequency of such spikes during the last 3-year period. This underscores a reason why vol-of-vol (VVIX) continues to reach historic new highs versus vol.
Some more details on the actual underlying mechanics of the intraday move:
VIX inverse ETP positions decrease; technical flow into the close pushes vol up: Positioning in long VIX ETPs remained largely unchanged last week at $200M long vega, while positioning in inverse VIX products decreased by over 30% down to $80M. The mechanical buying of VIX futures extended between the cash close at 16:00 EST and the futures close at 16:15 EST. To illustrate this technical flow one can look at the long VIX ETN, VXX. The index underlying VXX closed 15 minutes later than the ETN and recorded a 19.1% daily return, significantly more than VXX itself. As can be seen on Chart 19, large and positive return differentials tend to auto-correct in most cases during the following trading session.
What was just as remarkable, of course, is that as the VIX spiked by a gargantuan amount, the S&P appeared almost not to notice, dropping just modestly over 1% from levels near all time highs: almost as if nobody even bothered to actually sell the underlying securities that set volatility, or in other words, "almost as if" this is a market in which the only securities traded are derivatives, with little regard for the actual stocks.
Finally, what happened on Monday as visions of mushroom clouds rapidly receded after various US officials said "nuclear war was not imminent" was just as remarkable: "The spike in vol was followed by a near-record fast retracement as the VIX moved lower on Monday, and closed at 12.33 (Chart 21). The move in VIX was paralleled by the entire VIX term structure, which inverted on 10-Aug and switched back to being upward sloping by 14-Aug." In other words, just as the spike in vol was unprecedented, so the retracement was almost unmatched.
In other words, just hours after countless vol shorters were stopped out and left to nurse major losses as a culmination to one of the best runs in inverse VIX and short vol derivatives, a whole new army of robo-traders, algos and the occasional human, took their place and sent the VIX crashing back to near record low in one of the shortest timeframes on record.