Vega volumes triple on Vix spike

Rebalancing of Vix ETPs spurred record trading in Vix futures on August 10

Trading activity in Vix futures hit record levels last Thursday (August 10) as levered and inverse volatility exchange-traded products (ETPs) scrambled to rebalance their holdings.   

The S&P 500 index fell 1.5% that day amid rising political tensions between the US and North Korea, while the Vix – a measure of expected volatility in the US stock market – leapt from 11.11 to 16.04, a move of more than 44%.

As volatility rose, inverse Vix ETPs – which have seen big inflows from retail investors in the past year – tried to exit short positions by buying volatility and going long vega, a measure of a product’s sensitivity to changes in the volatility of the underlying.

Research from Bank of America Merrill Lynch shows $850 million of vega was traded in Vix futures alone on August 10 – compared to around $250 million on a typical day – with ETPs accounting for almost 6% of this volume.

“We estimate that the levered and inverse Vix ETPs bought over $50 million vega into the close as part of their daily leverage reset. This is a lot of volatility,” says Nitin Saksena, head of US equity derivatives research at Bank of America Merrill Lynch in New York.

Analysts at a number of other firms back this up. “Thursday was the second biggest day for Vix ETPs in value traded, at $11.5 billion – second only to August 24, 2015 [when the Dow Jones Industrial Average fell over 1,000 points in early trading] – and the third biggest day for Vix futures rebalancing. There was a net buy-in of 52,000 futures [contracts], or $52 million in vega,” says Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors, a New York-based research firm.

Researchers at BNP Paribas peg the amount of vega purchased for hedging purposes on the day at $52 million, while Societe Generale puts the figure at $39 million.  

“Given the positioning in the short and leveraged ETPs and given the move we had, especially on Thursday, in our estimate roughly 39,000 contracts had to be bought on the close to rebalance all the positions,” says Aymen Boukhari, a strategist at Societe Generale Corporate and Investment Banking in London.

Analysts say short positioning in the market leading up to August 10 – at least partly driven by the popularity of inverse Vix ETPs among retail investors – may have contributed to the disproportionate spike in Vix futures trading on the day relative to the move in the S&P 500.

“If we look at the CFTC reported positions as of last week for speculators, the position was roughly short $150 million vega in the Vix futures,” says Boukhari. “It just tells you there was probably some forced buying back of the positions given the move during the day and at the end of the day there was ETP rebalancing. So all that makes it look like the Vix futures were way too sensitive to the relatively small move we had on the S&P spot.”

Anand Omprakash, an equity derivatives strategist at BNP Paribas in New York, agrees: “What happened over the last few months and the last week was that there was some pretty significant pick-up in the increased assets under management in the short Vix ETPs, like the XIV, and that has actually reduced total amount of ETP vega outstanding. When you have someone buying XIV, technically they are shorting Vix futures, and that is reducing the net long position in the Vix futures outstanding from people who are buying these ETPs.”

Vix is a volatility index managed by CBOE

Retail investors have been flocking to inverse Vix ETPs over the past year despite warnings that the complex structure of these products means they are only suitable for sophisticated investors, such as hedge funds engaging in short-term trading.

The products aim to profit from falling volatility by shorting Vix futures of different maturities. The underlying position is then rebalanced by buying or selling more futures as volatility moves in order to maintain a fixed level of leverage – typically 100% or 200% – in relation to the index.

XIV, issued by Credit Suisse, was the largest inverse Vix ETP as of July 28, with around $833 million in assets. The ProShares SVXY ranked second, with roughly $446 million of assets. Both took a beating on August 10, with the XIV and SVXY dropping more than 13% on the day.

Vix ETPs – both long and short – are also exposed to gamma risk, which means buying or selling pressure on the underlying futures resulting from a move in volatility can push volatility further in an unfavourable direction, exacerbating losses.    

BAML’s Saksena says this was observed in the VXX, a long Vix exchange-traded note.  

“The Vix futures-based index underlying VXX was up 19%, significantly more than VXX itself, reflecting mechanical buying pressure in Vix futures from the 4pm cash close to the 4:15pm futures close,” he says.

Another key feature of inverse Vix ETPs is that they have stop-loss triggers, which would force investors to redeem their securities at market levels. This is set at an 80% one-day move for the XIV, for instance.

Saksena says a stop-out scenario is unlikely, however – especially since volatility moved to a higher level on August 10.   

“Subsequent risks may be less acute now that volatility is off the lows,” he says. “Put simply, a spike in the Vix one-month future from 12 to 15 is a bigger deal than from 15 to 18, as percentage returns in volatility drive flows for the major Vix ETPs. This is similar to many quant strategies, which tend to be most vulnerable to a big one-day shock from an ultra-low vol base but become de-fanged by any slower build-up in volatility.”

BNPP’s Omprakash says the big one-day loss and frantic rebalancing activity on August 10 are unlikely to scare off retail investors, who remain enamoured with inverse Vix ETPs.   

“In spite of what has happened the overall positioning in these short Vix ETPs remains historically elevated,” he says.