There are underlying options on the S&P 500 that trade on exchange or OTC (depending on size and strike and margin package – arb or outright). On top of that set of options lies a world of futures and options on a ‘created’ VIX (that are predicated on the implied vols of the underlying S&P options). And to top it all off – the wonderful world of Exchange Traded Products (ETPs) overlays various levered and unlevered short and long products for retail (and professionals) to speculate on (and some have their own compound options). As you can tell – there is a large amount of ‘flow’ impacting up and down the chain in this vol landscape.
Barclays has found that that flow – when aggregated across all the instruments accounts for around $5.3mm notional of selling volatility day after day in flow that needs to be pushed down through the underlying markets. This is just by construction in the way the ETPs are created.
This is why your position in say VXX decays. So while its easy to blame Kevin Henry, he is getting a solid leveraged hand from the ‘other side’ of hedgers rebalancing their ETP exposures. And at current levels, it appears demand is high for protection (which perhaps explains why stocks are not dropping as one would suspect they should).
The following table sums up all the VIX-related products and the final two columns show the ‘flow’ that theoretically has to move to the underlying options day after day…
and it seems in the run-up to the fiscal-cliff to now, open-interest in VIX futures has surged… but appears to have stabilized for the last week or two (even as stocks pushed on higher)
and of course the massive net short in VIX futures (commitment of interest) has pressured Equity vol even lower – to the point at which it is at 5-year lows relative to credit vol and we suggest warrants some further investigation for a long equity vol vs short credit vol trade…
So while this ‘flow’ will pressure vol and ramp stocks implicitly as market-maker algos hedge away, there is a limit and maybe (on a relative basis) that limit is close… especially to credit
Charts: Bloomberg and Barclays