Two weeks ago, when discussing the self-reinforcing dynamics among systemic vol-sellers, JPM’s head quant had a dramatic warning: in a nutshell, he said contrary to the assumption that the market will always rebound in a BTD kneejerk response, days like May 17th and similar events “bring substantial risk for short volatility strategies.”
While there was much in his research report from June 13, it was his conclusion on why the current market tranquility is masking what may be a “catastrophic”, self-reinforcing “market” crash as all those vol-selling strats suddenly go into reverse, that was most notable:
Given the low starting point of the VIX, these strategies are at risk of catastrophic losses. For some strategies, this would happen if the VIX increases from ~10 to only ~20 (not far from the historical average level for VIX). While historically such an increase never happened, we think that this time may be different and sudden increases of that magnitude are possible. One scenario would be of e.g. VIX increasing from ~10 to ~15, followed by a collapse in liquidity given the market’s knowledge that certain structures need to cover short positions.
Well, following the dramatically hawkish posture by central bankers in the past 72 hours, the market finally woke up, and as of a few moments ago, VIX above 15, hitting 15.16, rising more than 5 points, or putting the market right into Kolanovic’ “catastrophic loss” territory.
What about overall market liquidity? Courtesy of Nanex, here is where we stand right now.
Which leads to two questions: i) Will today’s selloff lead to a broad deleveraging among vol-sellers who are forced to cover into a sharply rising VIX, and ii) will the risk parity funds finally be forced to unwind?
Which also means a bounce is likely imminent. And while we wait, as a reminder here is the risk-parity liquidation matrix based on intraday moves in both bonds and stocks. Any moves into the orange space could be hazardous for bulls’ health.