There have been some important developments in the volatility markets that I feel investors need to be mindful of – particularly now.
Historically, investors have become accustomed to seeing extreme ‘Volatility Events’ roughly every 10 years (1987, 1998, 2008). Effectively, investors would immediately become more risk-aware and it would take time for enough complacency to infiltrate the markets again as the prior collapses became further in the rear-view mirror.
Since the global financial crisis, Government regulation in the form of Dodd-Frank and Fed stress tests have severely curtailed bank balance sheets and bank’s ability to provide clients hedging in the form of selling options*. This void in the market was filled by volatility targeting firms such as, levered VIX ETPs as well as active and passive volatility selling strategies. This trend, particularly from 2015 through 2017, led to an abundance of volatility sellers and subsequently to the historically depressed levels seen in the VIX throughout 2017. Then, in February of 2018, the aptly coined ‘Volmageddon’ happened and the seemingly free-money, levered ETPs caught investors off guard. This caused products to close and many individual investors suffered dramatic losses. It appeared the decks had been cleared of most of the levered short volatility players. However, the dramatic market decline suffered in Q4 of 2018 led to additional pain in the space as passive put writing and condor strategies ran into difficulty. Finally, in March of this year we had yet another volatility event caused largely by the Corona Virus. This led to many active short-volatility managers engaged in ratio spreads and variance swaps going out of business.
3 major volatility events in the space in just over 2 years. It makes one yearn for the prior ten-year increments… My feeling is that, in large part, this decline in vol-selling pressure (in addition to Corona related fears, Socio-Economic turmoil and geo-political concerns) will lead to an extended period of an elevated VIX and that the spread between implied and realized volatility will be with us for quite some time. Another development of late is the dramatic increase in individual investors in the options market. The focus given to options trading on CNBC is but one indication of the prevalence of this trend and the following chart prepared by Morgan Stanley of the dollars chasing less than 50 contract orders is a glaring confirmation.
What we have noticed though is it appears that retail has lined up on the single stock call buying side while Institutional traders such as Hedge Funds and Banks appear to be large buyers of index puts to hedge exposures. It has also been interesting to see that from a global investing perspective, this is predominantly being done in the US and not foreign markets. This is very reminiscent of 1999, if anyone remembers dot com 1.0.
Also, worth consideration is that if we do get a Corona Virus vaccine sooner than expected and this causes implied volatility to fall dramatically, do all the short gamma strategies that are currently underweight equities need to rush in? The below chart, also from Morgan Stanley, gives us a sense of the impact this might have. A VIX below 20 will send our risk parity/vol targeting friends back to the leverage game!
Given the recent run in the markets since April and if the market rise continues, thinking back to our individual single stock call buyers, it might lead one to ask: “Who is the ‘smart money’ now……. “
Partner, Portfolio Manager
Disclaimer and Other Important Information:
Not an offer and confidential: This site and the information in it is provided for your internal use only. The information contained herein is proprietary and confidential to Harvest Volatility Management LLC (the “Adviser”) and may not be disclosed to third parties or duplicated or used for any purpose other than the purpose for which it has been provided. The information presented herein may contain expressions of opinion, which are subjective, may be difficult to prove, and are subject to change without notice. Additionally, although the information provided herein has been obtained from sources which the Adviser believes to be reliable, we do not guarantee its accuracy, and such information may be incomplete or condensed. The information is subject to change without notice. This communication is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security or of any fund or account (a “Fund”) the Adviser manages or offers. Since we furnish all information as part of a general information service and without regard to your particular circumstances, the Adviser shall not be liable for any damages arising out of any inaccuracy in the information.
This site and the information contained in it should not be the basis of an investment decision. An Investment decision should be based on your customary and thorough due diligence procedures, which should include, but not be limited to, a thorough review of all relevant term sheets and other offering documents as well as consolation with legal, tax and regulatory experts. Any person subscribing for an investment must be able to bear the risks involved and must meet the particular Fund’s suitability requirements. Some or all alternative investment programs may not be suitable for certain investors. No assurance can be given that any Fund will meet its investment objectives or avoid losses. A discussion of some, but not all, of the risks associated with investing in the Fund can be found in the Fund’s investment advisory agreement, private placement memoranda, subscription agreement, limited partnership agreement, articles of association or other offering documents as applicable (collectively the “Offering Documents”), among those risks, which we wish to call to your attention, are the following:
Future looking statements, Performance Data and strategy level performance reporting: The information in this site is NOT intended to contain or express exposure recommendations, guidelines or limits applicable to a Fund. The information in this report does not disclose or contemplate the hedging or exit strategies of the Fund. While investors should understand and consider risks associated with position concentrations when making an investment decision, this report is not intended to aid an investor in evaluating such risk. The terms set forth in the Offering Documents are controlling in all respects should they conflict with any other term set forth in other marketing materials, and therefore, the Offering Documents must be reviewed carefully before making an investment and periodically while an investment is maintained. Statements made herein include forward-looking statements. These statements, including those relating to future financial expectations, involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Unless otherwise indicated, Performance Data is presented unaudited, “net” of management fees and other expenses, and net of performance allocations. Returns presented may reflect the reinvestment of dividends and other earnings. Due to the format of data available for the time periods indicated, both gross and net returns are difficult to calculate precisely. Accordingly, the calculations have been made based on in some cases limited available data and a number of assumptions. Because of these limitations, the performance information should not be relied upon as a precise reporting of gross or net performance, but rather merely a general indication of past performance.
The performance information presented herein may have been generated during a period of extraordinary market volatility or relative stability in a particular sector. Accordingly, the performance is not necessarily indicative of results that the Fund may achieve in the future. In addition, the foregoing results may be based or shown on an annual basis, but results for individual months or quarters within each year may have been more favorable or less favorable than the results for the entire period, as the case may be. If index information is included, it is merely to show the general trend in the markets in the periods indicated and is not intended to imply that the portfolio was similar to the indices in either composition or element of risk. This report may indicate that it contains hypothetical or actual performance of specific strategies employed by the Adviser, such strategies may comprise only a portion of any specific Fund’s portfolio, and, therefore, the reported strategy level performance may not correspond to the performance of any Fund for the reported time period. Please note that the Adviser calculates its assets under management with respect to its overlay strategies based on notional valuations and mandate sizes rather than market valuations.
Investment Risks: Investing in a Fund is speculative and involves varying degrees of risk, including substantial degrees of risk in some cases. A Fund may be leveraged and may engage in other speculative investment practices that may increase the risk of investment loss. Past results are not necessarily indicative of future performance, and a Fund’s performance may be volatile. The use of a single advisor could mean lack of diversification and, consequently, higher risk. A Fund may have varying liquidity provisions and limitations. There is no secondary market for investors’ interests in a Fund and none is expected to develop.
Not Legal, Accounting or Regulatory Advice: This material is not intended to represent the rendering of accounting, tax, legal or regulatory advice. A change in the facts or circumstances of any transaction could materially affect the accounting, tax, legal or regulatory treatment for that transaction. The ultimate responsibility for the decision on the appropriate application of accounting, tax, legal and regulatory treatment rests with the investor and his or her accountants, tax and regulatory counsel. Potential investors should consult, and must rely on their own professional tax, legal and investment advisors as to matters concerning a Fund and their investments in a Fund. Prospective investors should inform themselves as to: (1) the legal requirements within their own jurisdictions for the purchase, holding or disposal of investments; (2) and applicable foreign exchange restrictions; and (3) any income and other taxes which may apply to their purchase, holding and disposal of investments or payments in respect of the investments of the Fund.
This is not a solicitation to buy or an offer to sell interest in our funds, such offers will be made only by distribution of a private placement memorandum and only in compliance with applicable law.
1Please note that the Adviser calculates its assets under management with respect to its overlay strategies based on notional valuations and mandate sizes rather than market valuations. AUM is as of 12/31/2020.