Volatility Suppressed

For nearly three months now, 0DTE (options expiring within 24 hours) players have suppressed volatility. Any intraday increase in VIX is quickly met with mean-reversion trading of options which effectively counters all but the strongest of trends. The problem with this is that suppressed volatility eventually breaks out of its cage. The last time this happened was in 2018, and the event is now called “Volmageddon” or “Volpocalypse”. VIX doubled in a short time, which was not too serious for the major indexes but wiped out a number of leveraged VIX-related ETFs. This time the potential risk is much larger because the volatility suppression is really a side effect of an options strategy which is able to directly cause a major move. JP Morgan estimates that a 5% move in the S&P would trigger a further 20% crash as the options writers moved to hedge their positions by selling stocks and futures. But to further aggravate the situation, the open interest in VIX calls is at an all-time record as some traders believe this suppression cannot last indefinitely, and will blow up at some point. A sudden rise in VIX would cause these calls to create a gamma squeeze in VIX, driving VIX still higher and increasing the selling by the options writers. More than $1 trillion notional of 0DTE options are being traded every day. This is idiocy. The selling would be entirely automated, just like the “portfolio insurance” that caused the 1987 crash.

OTOH there’s a lot of idiocy around right now. A clue is that “Mr. 50 cent”, a very large and successful VIX options trader known for the signature habit of buying large quantities of options for, well, 50 cents, has taken a call position. This person (or fund) is not an idiot and has been absent for a while, after racking up an estimated $200 million profit in the 2018 event. In all fairness that $200 million was actually a $400 million profit offset by $200 million in losses stemming from being early. That’s conviction.

Both comments and trackbacks are currently closed.