As insane as the market moves were during regular trading hours on Monday, some extraordinary things happened in volatility products of late. Yesterday the yen was the top performer while the pound lagged. The RBA decision is due up next. The Premium video on yesterday's wild market swings (biggest intraday point decline in the history of the Dow) will be posted later tonight. Stay tuned.
Betting against volatility is one of the infamous trades of all-time. It's so lucrative, so perfect that it pays over and over again – until it doesn't. Betting against volatility was the trade that took down the famed hedge fund Long Term Capital Management and resulted in a Fed-led bailout in 1998.
Now, it's an even bigger trade. In a recent poll from BAML, fund managers cited short-volatility as the most-crowded trade. The VIX fell below 9 in early January.
As Ashraf warned last week, volatility has spiked. The VIX closed at 37 on Monday as it doubled. But that's just where the story begins. Something happened in after-hours trade to the iPath S&P 500 VIX Short-Term Futures Exp 30 Jan 2019 ETF (NYSE:VXX). It closed at 99 after opening at 115. It's designed to trade inverse from longer-dated VIX futures. It was a sharp, painful fall but it was orderly. In after hours trading, it fell to 28.
No one is quite sure what happened. There are some provisions for a liquidation in the ETF but it's not clear if the provisions were met. A similar move happened in ProShares Short VIX Short-Term Futures Fund (NYSE:SVXY), which is a similar ETF.
It's possible that some kind of fund liquidation and margin call event is underway but it could also be a liquidation that feeds back into volatility on Tuesday. If it's liquidated, then volatility is going to continue to spike Tuesday and it could get much uglier from here as funds are wiped out in the same way LTCM was.
If so, the yen is particularly attractive until the dust settles.
In the bigger picture, the RBA held. If they had made a hawkish shift, it would have been at a terrible time for equity markets and sentiment in general.