The 6/10 “Momentum Flash Crash”

6/10/17 was a very strange day in the markets. There are plenty of places to read about the causes (here for example). Essentially tech led a very nasty volatility move up in the middle of the day. Whats really strange is that this happened just as the VIX hit ~25 year lows and the S&P500 hit all time highs around 2445. You can see the highlighted point below.

Here is Amazon stock chart as an example from Business Insider:

Screen Shot 2017 06 09 at 3.14.02 PM


This to me is showing how volatility and stock price are decoupling. From peak to trough the VIX moved up 27% in just a few quick hours, and closed ~+5%.  The “NASDAQ VIX” (symbol VXN) was up over 30% and closed there. You can see in the chart below how large and fast that move was.

Yes, the NASDAQ index was down 2.5% for the day, but the S&P500 was dead flat.

I think this is a sampling of whats to come. Major volatility moves relative to actual index price moves.

How’s the Weather?

What else is there to talk about? Volatility is dead and we are all being lulled to sleep. I think we are eventually going to see a major breakout in volatility and a “shift” from short volatility bias to long volatility bias. My feeling is that it starts later this year *if* Trump can’t get his tax agenda through. Its hard to believe he will have success with that considering the constant force against him.

Preparing for Volatility Expansion in Investor Portfolios


Preparing for Volatility Expansion in Investor Portfolios


As advisors work to position client portfolios for market conditions which may lay ahead, a common question is how certain investments may perform in an expanding volatility environment—an important consideration given recent low levels of volatility—and historical patterns of reversion.

When looking at the long-term average of volatility, it’s widely accepted that volatility tends to exhibit mean reversion traits. Using the VIX, a volatility index that represents the market’s expectation of 30-day volatility, one can see these reversion tendencies.

Daily VIX Price
Daily VIX Price

At the time this article was written, only 3 days—out of 6,889 observed days of VIX prices—closed below the May 8, 2017 price of 9.77. Those days came during Christmas week in 1993. Following that time period, implied volatility expanded roughly over the next two and half years, taking the VIX above the long-term average where it would continue its upward climb before bouncing between 20 and 40 until 2004. After a period of compression, a similar pattern of expansion can be seen again from late 2006-2007 before the Financial Crisis pushed the VIX to all-time highs.

Since 2008, the trend has been primarily one of continued compression—minus a few pockets of volatility in 2010, 2011 and again in 2015. This trend has pushed the one-year average VIX to a level below that observed in 84% of all other rolling one-year periods.

It’s true that the very calculation of the VIX implies that volatility levels are likely to stay low for at least the near term, and predicting exactly when the expansion will start is futile. With that said, only in the financial markets do people equate variance with risk. According to Merriam-Webster, investment-related “risk” is defined as the chance that an investment (such as a stock or commodity) will lose value. And, often times it is after market risks manifest themselves through loss that volatility spikes. Luckily, the purpose of proper portfolio construction is not dependent on the exact timing of these events, but rather an intuitive mission statement that may go something like this: “To position portfolios in such a manner to give the investor the greatest chance of prudently growing capital in accordance with the investor’s goals and risk tolerances given a likely forward looking environment.” In this case, the likely forward looking environment is one of expanding volatility, thus the question that
started this piece is appropriate to examine.

How should low volatility strategies such as, 361 Long/Short Equity Strategy, perform in an expanding volatility environment?

361’s Long/Short Equity strategies, sub-advised by Analytic investors, pioneers of the research surrounding the low volatility anomaly, combine two return-generating ideas where they look at the investable universe through two separate lenses. One lens is solely focused on returns, while the other is solely focused on the stocks’ risk profiles by using predicted betas. After risk controls for individual holdings and constraints are applied, the portfolio is optimized on predicted risk and return characteristics. The portfolios can be expected to have a net exposure of 70% over time, but with a beta much below what might be assumed, given that exposure level. In fact, the strategies have both targeted and realized betas of between 0.4-0.6, while attempting to match the return of the market over time.

When examining equity markets across quintiles of volatility, assuming CAPM holds, one would expect the lowest volatility stocks to underperform the highest volatility stocks. However, that is not what has been observed over time. Indeed, there is actually a relatively flat payoff to risk quintiles using simple averages, and that payoff falls off as you move across the curve to higher volatility stocks once you take into account that impact that volatility has on compounding.

The reason this is important background is twofold. First, generally these portfolios look to be 100% long the lower volatility stocks of a given market and 30% short the highest volatility stocks (Net 70% with a targeted beta of 0.4-0.6). Second, there are specific timeframes when high volatility stocks do outperform low volatility stocks. Those timeframes are generally during periods of volatility compression, or more appropriately, compression of implied volatility (VIX) associated with “risk on” environments like that observed in the U.S. for most of 2016. Conversely, during periods of a market’s implied volatility expansion, high volatility stocks underperform, and at times significantly. The chart below examines domestic stocks and volatility using the VIX, and different quintiles of returns of the Russell 1000 grouped by volatility.

Periods of VIX Compression: Low Vol – High Vol*

The red arrows and corresponding numbers represent the low volatility minus high volatility spread during time periods of overall VIX compression, while the green arrows and corresponding numbers represent the same spread during time periods of VIX expansion. It’s clear that low volatility stocks have historically performed better than high volatility stocks during periods of volatility expansion. To represent this further, the graph below compares cumulative returns for both low and high volatility stocks during “extreme” time periods. Here the graph examines the run up of tech stocks and subsequent collapse, as well as the financial crisis.

Cumulative Return Low Volatility – High Volatility with VIX

This graph also demonstrates that when high volatility stocks vastly outperform low volatility stocks, it is during times of “risk on” environments that have historically been associated with a compressing VIX. Conversely, low volatility stocks outperform as investors seek relative safety during periods of fear and thus an environment with expanding VIX.


It is not likely that volatility will remain at these low levels and investors need to prepare for a return to something resembling normality at some point in the not too distant future (and when that occurs, it will likely blow through “average” if history is any guide). Given investing is a forward-looking exercise, this means investors need to be thinking about how portfolios will perform when volatility does normalize (i.e., how best to include investments that benefit from an expanding volatility environment). While past performance is not indicative of future results, 361’s Long/Short Equity strategies may perform well given the structure of the stock compilation generally being long low volatility stocks while maintaining a short position in the higher volatility stocks. If expanding VIX levels do in fact occur and the historical pattern holds, which seems likely given the desire for investors to move to “safer” investment in the face of uncertainty, this positioning should be favorable

“Low Volatility Is Not the New Normal”

Co-Inventor Of VIX Warns Low Volatility Is Not New Normal

“Historically there seems to be a new group of people each time that underappreciates the very significant risks of being short volatility and wants to learn this expensive lesson.”

Co-inventor of the VIX index, Sandy Rattray is CIO of Man Group, CEO of Man AHL, and a member of the Man Executive Committee, and he has a clear message for investors – he believes it is extremely unlikely that today’s low realized volatility represents a ‘new normal’.

In conversation with Goldman Sachs’ Allison Nathan in her bi-weekly ‘Top Of Mind’ letter, Rattray warns “The market is underpricing tail risk today.”

Asked about the current popularity of volatility-selling, Rattray responds…

Across many previous cycles, volatility selling tends to be quite popular after long periods of relatively low volatility and unpopular just after volatility has spiked – the reverse of what would seem to be rational.

So the fact that there’s lots of volatility selling at the moment isn’t particularly surprising in my view. Historically there seems to be a new group of people each time that underappreciates the very significant risks of being short volatility and wants to learn this expensive lesson.

In my view, shorting volatility should only comprise a relatively small part of a portfolio, and should have a clear risk-management process around it. If you don’t follow those two rules, then you could potentially end up in significant trouble. There is no question that these short-vol strategies can pose significant risk to individual investors pursuing them if they are not managed appropriately.

That said, I’m not sure these volatility sellers are impacting the market any more than usual. The reality is the low levels of the VIX are fairly consistent with low levels of realized volatility; S&P 500 30-day realized volatility is about 6.6 now, and the VIX is about 10.6, versus a long-term spread between implied and realized volatility of about three to four points. So I don’t think we can blame much on volatility sellers themselves. I see them as playing their traditional role of keeping supply and demand for implied volatility in equilibrium.

And in that context, Rattray has some advice for traders and investors today…

People often ask whether we have a new, lower normal in realized volatility. I believe with some conviction that we don’t. The very low-volatility environment today will end at some point, although it is very hard to forecast why and when that will happen. But we’ve had a fairly strong and continuous rally in equity markets around the world since 2009, and equities in a number of countries, particularly the US, don’t look terribly cheap today in my view. That does not mean that equities are going to correct in the near term. But it is unimaginable that equities don’t correct at some point.

And echoing JPMorgan’s Kolanovich…,

The focus is now back on central banks, with the probability of a June 14th hike rising after the FOMC meeting yesterday (probability now at ~80%). A potential risk-off scenario could be a combination of macroeconomic data slowing, but the Fed proceeding with normalization. Neither a modest macro slowdown nor Fed tightening is likely to tip over the market on its own. However, if it happens in the seasonally weak time period, and if it trips up some of the volatility sensitive strategies (e.g., volatility selling, volatility targeting, etc.) the increase of volatility could be more substantial. For these reasons investors should closely monitor incoming macro data

Rattray sees one group in particular as a potential catalyst…

One concern is that many people choose to scale their positions by the level of realized volatility, which means there could be very large positions out there today with potentially significant leverage that might be vulnerable should volatility rise whether due to a tail risk event or other developments in the market.

So it is important that investors have a plan for when the market environment changes. That plan could potentially involve a hedging strategy, a fund-management strategy, or it could come down to asset allocation or rebalancing—though rebalancing, of course, may exacerbate drawdowns. One size does not fit all here, so there is no one clear strategy to pursue.

What is clear, Rattray concludes, is that there will be a sell-off in risk assets at some point, and the investors who are unprepared are those who will potentially fare the worst.


SNAP is a Sign

Possibly because I am not a millennial I just didn’t understand Snapchat. Not their application and use, but their valuation.  It is cute technology used by children. As far as I know there is little to no moat, and some very major competitors vying for short attention spans. It looked to me like a way for all the investors to cash out, dumping the thing on retail investors. To me, the IPO it was some sign of a peak. Maybe peak VC, peak Silicon Valley. I’m not saying its all dead, but the easy money is.

After the IPO SNAP traded to just under $30 – a $35 BILLION valuation. For this:

snapchat image

It now appears easier to say in hindsight after their horrid earnings last night, but there is still a long way for SNAP to go zero.


The Cheapest Volatility

The VIX hit its lowest levels since 1993 this week, and that captured headlines. Whats most interesting to me is the spread between realized and implied volatility. Realized shows how much the market is actually moving, whereas implied is what the market thinks volatility will be.  During sudden shocks or crisis’ (BRExit) realized volatility can trade above realized. In normal markets realized is less than implied.

The chart below shows current implied (yellow line) vs realized (blue) in the SPY.  I like to think that (during “normal” markets) when the spread (the gap between the lines) narrows that volatility is “cheap”. For instance December in the chart below. In April there was major hedging of the French elections, so the IV spiked way up. The underlying market however didn’t budge.


Whats interesting about the current market is that realized volatility is essentially at historic lows. It could drift a bit lower, but its basically on life support. Implied volatility has really dropped after the French election as well, almost to the level of realized. So the situation is that realized is about as low as possible, but implied is right there with it. If they are both literally on the floor there are only two outcomes:

  1. Volatility continues to trade sideways
  2. Volatility gets up off the floor

I am not forecasting impending doom, I am just noting that it seems to me that the risk reward of shorting volatility is not as good as it was a few months ago. So, whether you’re long XIV, short VXX or in variance swaps I’d be cautious.

Remember – Volatility Mean Reverts

Its something everyone loves to say when the VIX is  at 20 or 30, heck even 15. Yesterday we hit lows in volatility not seen since 2007.

The spread between realized volatility (SPX realized is ~7) and 3 month SPX implied has come in quite a bit as per Bloomberg. In April realized was ~7 but implied was ~12. So from that standpoint, volatility is “cheaper” now than its been over the last few months.

Maybe its time to think about unwinding that short vol trade…

VIX lows

Weird SPX/VIX Correlation

There are constant claims that volatility ETPs are impacting the market in strange ways. I don’t pretend to understand what caused the SPX/VIX correlation to break like it did in late March, but wanted to make note of it. Looking at the top chart you can see the correlation, with an average of -0.88. This obviously means that the correlation between the two is strongly negative – SPX goes down VIX goes up. What just came in March was SPX and VIX going up at the same time.

As you probably know, recently the S&P500 refuses to sell off, and when people pile into hedge that raises volatility. Much of this was due to the French election, but there was also a strange mini-breakdown in late December ’16.

The easy answer seems to be to blame it on the volatility ETPs (VXX, UVXY, SVXY, XIV, etc). I feel (anecdotally) that its more due to the fact that stocks do not want to sell off.

VIX SPX Correlation
Correlation Between the VIX and the S&P500 SPX

Hedging the French Election

This is being written for tracking purposes just to followup post election to see how these trades performed. I’m actually most curious to see how GBP reacts and if it becomes something of a safe haven in the event of an “anti-EU” election outcome.

French Election Hedges and Their Estimated Price (4/21/17 ~10AM Est):

  • Euro Stoxx 50: 3441
  • S&P500: 3253
  • V2X index (EU version of the VIX): 25.67
  • VIX: 14.38
  • EUR/USD: 1.07
  • GBP/USD: 1.278
  • German Euro-Bund bond futures : 162.68
  • French OAT bond futures: 148.24
  • Gold: $1283/usd


Paris Shooting

Police offers were just shot in Paris, 3 days before the election. Volatility sold off all day and the US market rallied as the latest polls gave Macron a better lead.

Paris Shooting
Paris Shooting

The French have no said who is responsible – but *if* its a terrorist (as in Islamic) attack will that substantially swing things? You’d have to think that this tilts things slight more toward Le Pen…

The close today might have been a great time to add some hedges as the markets could react sharply overnight on this.