XIV Post-Mortem: We Honor the Dead

I’m tempted to leave sorting through the short-vol/XIV wreckage to the rest of the financial blogosphere. I mean look, we’ve all been around the block--as Matt Levine at Bloomberg said, it isn’t that complicated, you bought a product that was short something, that something went up 100%. Your equity is wiped out. Thanks for playing, we have some lovely parting gifts for you.


This isn't shadenfreude.  I take no joy in the destruction. I simply find it amazing that someone with a ton of firepower figured out exactly how and when to crush the world’s most liquid market at just the right time, and in just the right way to trigger a massive vol puke. It was like a boxing match where there is little action for nine rounds, then one guy takes a punch, hesitates momentarily, and then gets clobbered by a vicious, match-ending combo.


Congratulations on your squeeze, whoever you are. It was a thing of beauty, and I’m sure there was champagne and steaks for all when the XIV-enemy was vanquished and victory was declared.  Just don't fool yourself into thinking you're creating any real value.




Meanwhile in risk-parity land, there were more than a few nervous managing directors as the financial media swarmed around the idea that robots triggered the meltdown. Just to be on the safe side, Bridgewater and AQR  put out a joint press release  were quoted in a WSJ article today in defense of risk-parity. “It is definitely not driving global asset prices. It just sits there like a turtle,” Bridgewater CIO Bob Prince said. “We have done pretty much no trading in risk parity” Cliff Asness of AQR said.


I’m sure that’s true, but it highlights how this was an orchestrated squeeze rather than a real crisis. Spoos may have taken a big dump, but market liquidity backstopped the selloff once strong hands figured out what was going on. So AQR and Bridgewater didn’t have to do anything--they just let their models keep doing their thing. They had little to fear from outflows or any type of financing squeeze for their leveraged positions. They won’t be so fortunate when this type of event happens in the midst of a real liquidity crisis that strangles financing capacity.


What happens next--there are a few points short term: The quant folks at JP Morgan think this shock to systematic trading/short vol “asset class” will generate as much as $100bn in outflows from these strategies. I don’t think that has a macro impact other than to leave less of an offer for vol when the market stress subsides. That means lower asset values and wider credit spreads at the margin, but not dramatically so. Second, I agree there is likely still a residual hedge to be unwound for whoever is wearing the position that Credit Suisse dumped on them when the market went berserk earlier this week. They will find a way to parcel it out over time--that’s what these guys do.


The mentality--or flows-- to make money from short gamma and/or tighter ranges within a rising, low-vol, risk-on market isn’t dead.   I continue to believe this event won’t permanently break the market, but I do believe it could be remembered as the event where we should all have known quant strats and yield-chasing have gone too far. It reminds me of mid-2007, when Northern Rock blew up.  I remember a prominent newsletter author saying at the time that the market had to give up a big whale….and Northern Rock was it. Well, the market had to give up a big whale alright, but it wasn’t Northern Rock.


XIV is far from a whale--heck, it isn’t even a Northern Rock. XIV is more like a small trout some big bank or hedge fund just pulled out of a river. This market isn’t out of kerosene quite yet.

Previous
Next Post »

29 comments

Click here for comments
johno
admin
February 8, 2018 at 4:31 PM ×

Here, here. Well said.

Took chips off the table Wednesday. Too much "healthy correction," "all technical" talk while bonds were promptly resuming their selloff. The S&P is down >1% and the 10Y is up 3bps. This is not a good fact pattern. Not saying we have the onset of a bear market (that would be a violation of the Gartman-is-always-wrong rule), but braced for some chop.

Reply
avatar
johno
admin
February 8, 2018 at 4:58 PM ×

All that said, I just took another small bite at the VIX apple. EURSEK is at interesting levels again and loaded up there. Earlier today took off EURCHF. I failed to pick up the narrative shift in January ... was trading very unresponsively to what should have been constructive data if my narrative were right. Damage limited to some option premium, but initiated a cash position the other day ... just wasn't trading right so bailed. Thank goodness ...

Re duration, who the f-ck knows. Read the PTJ letter this morning. Whatever. "I feel like a young man again" or words to that effect. I'll believe the regime shift when I see it, and when I do, I'll move fast, fast, fast. So will everyone, so it'll be wild. If it ever comes. Maybe they'll euthanize capitalism before then ...

Reply
avatar
Shawn
admin
February 8, 2018 at 5:12 PM ×

I probably should have mentioned DR's post on the potential for a selloff in equities *and* fixed income as being the real panic-inducing event for the risk-parity funds. Still wouldn't matter though so long as the access to leverage doesn't dry up.

Reply
avatar
Nico G
admin
February 8, 2018 at 5:26 PM ×

- last month Ray Dalio joined the gang of funny money bulleez into calling anyone not thinking his way an idiot. It was an important moment in market history. Peak hubris followed by one standing ovation for a healthy correction that they declare over with immediate effect.

- in May 2009 a forum host said 'this new bull market will end when there aren't any buyers left'. It was absolutely intellectually impossible to imagine that the market would repeat its dirty trick, but it took 8 years and January 2018 to complete it

- at the depth of last crisis CFTC went to Chicago to ask CME to reduce margin trading by 50% the answer was you are asking us to cut our profits in half, it was nice talking to you. Fast forward 8 years and all the new 3x ETF toys showed Washington how it's done

- shawn is right anyone shorting volatility should have Deutsche Bank balance sheet backing them. Mauldin is going on his 'kill the quants' crusade. As an actuary myself, i fail to see what good financial engineering has brought to the world at large

- instead it facilitated and accelerated the fleecing of newbies by insiders - from the narrow open outcry of bygone days to an electronic poker table reaching billions of 'retail' amateurs Pavloved ad nauseam by financial media

Reply
avatar
johno
admin
February 8, 2018 at 8:51 PM ×

Ugly. Quickly cut away even that small (probably laughably small compared to my balance sheet, which Nico, I'd take over Deutsche's any day) VIX short. The market gets no traction, the Treasury auction was bad, and with the market down >2%, bonds are still down on the day! That fact pattern has to reverse, IMO. Bonds and stocks need to re-price to levels where the old correlation regime comes back. We saw it earlier in the week, which gave me hope, but it was fleeting.

Reply
avatar
Shawn
admin
February 8, 2018 at 9:59 PM ×

Still a snooze fest in high beta EMFX, oil, copper and FTQ assets. Wake me when JPY start getting squirrely, usd/try traders start getting carried out and bbg starts running stories with Shanghai, copper and collateral in the same headline.

Reply
avatar
Leftback
admin
February 8, 2018 at 10:01 PM ×

The XIV and its sibling products were an extraordinarily bad idea. It wouldn't be surprising if CS decided to took down their own ETF at some point (they would already have to be short XIV as a hedge), but any time there is a big pile of muppet money on the table that isn't being guarded someone on Wall Street will walk over and pick it up.

Ugly day indeed today, and a predictable bloodbath for the first group of Dip Buyers. The lows today were pretty close to the spike down on Monday so there might be some technical support there tomorrow. Weeklies expiring, we wouldn't be at all surprised to see equity shorts cover and vol longs take the money and run in the morning.

With that in mind, we didn't buy the dip in equities but we did sell vol late on. A little bit of blood in the streets today - and with the 2nd of a pair of VIX spikes now in place, we expect to see at least a moderation in fear tomorrow.

In USTs some of the auction results may be related to ongoing budget shenanigans in DC. There has been a tendency to just stay away from Treasury auctions when the government's policy is undecided. Why buy when you can wait and see?

As discussed here previously, high yield spreads have finally begun to widen as Treasuries finally found a floor. Keep en eye on that one, as well as the recent weakness in crude oil.

Wonder how Buy Stocks did today?

Reply
avatar
Polemic
admin
February 8, 2018 at 10:08 PM ×

i ve just been putting those on.
I really dont think this is over because no one has really worked out why it s happening and until they do they will be afraid to buy because they worry that they are missing something.

That close was horrific for the 'just' brigade

Just month end -> just stop losses -> just bond yield s so must just be inflation -> just a corection-> just a strange vol product that us normal eq managers don't have to worry about -> just WTF is going on !!!!

You are right the normal global stress things aren't moving but .... we know that pink flamingos like neighbor's lawns.
Tere is leverage in them hills and where there's leverage there is pain. Low yield has caused leverage and s here we go,

But it's stragly ironic that most of this is because of all the things tpost 2008 regs were designed to stamp out.
i see it as everything that post 2008 regs were put in place to stop -

ridiculous leverage

products that are toxic

bought by punters who have no clue

and sold by spivs who point at past performance

textbook


cheers Pol.

Reply
avatar
Polemic
admin
February 8, 2018 at 10:10 PM ×

oh and i like 5yr UST !

Reply
avatar
checkmate
admin
February 8, 2018 at 11:18 PM ×

So much for the 'high probability' play being consolidation. :) ...at least on this occasion.

Reply
avatar
February 9, 2018 at 2:29 AM ×

Dear Little Lefty, if you could send relevant paperwork related to , and only of what Kerry so kindly left me due to his unfathomable foresight in such matters of that time it would be appreciated to the extent that I will gladly be on my way.

Here is an address you can send said paperwork along with a short letter to the administration stating my name and student number :n9688471 with instructions to be passed on to moi.

QUT Business School
GPO Box 2434
Brisbane QLD 4001
Australia

Reply
avatar
Nico G
admin
February 9, 2018 at 3:26 AM ×

i don't know how old you are so in case you were all in kindergarten when the last bear market hit, just so you know, VIX reached 80+ intraday. If you still calibrate your thinking to the 2015-2018 sloth mode, shorting VIX at 40 might make seem like a no brainer, but you could still lose all your money

It is too early for this broken market to find footing because as johno and Pol said, noone knows what is going on the new Northern Rock and new Lehman have yet to come out. It will take many weeks to know who are the Harvey Weinstein of volatility selling, the Bill Cosby of short convexity and god forbid the darling Matt Lauer of high yield compression

watch Das Bank gently crashing, and watch HNA in China who decided to be the first card falling.

Reply
avatar
Nico G
admin
February 9, 2018 at 3:44 AM ×

don't you want to be a fly on the wall when orange dye Trump meets black dye Mnuchin today

'listen the stocks were a bubble BEFORE i came but i had turned them into a sound success'

Gary Cohn is gonna leave the ship soon and it won't look good- you can trust this guy knows the leverage out there

Reply
avatar
checkmate
admin
February 9, 2018 at 10:48 AM ×

We watch the closes now do we not? Going into the weekend you expect shorts to cover and put some money away. So, if that doesn't happen and we get another crap into the close it's a message all on it's own.

Reply
avatar
BlackRaven
admin
February 9, 2018 at 12:20 PM ×

" Second, I agree there is likely still a residual hedge to be unwound for whoever is wearing the position that Credit Suisse dumped on them when the market went berserk earlier this week. They will find a way to parcel it out over time--that’s what these guys do."

Why is there a residual hedge left to be unwound? I get the XIV has to be liquidated, but the aum/notional/whatever is tiny now. Also get that there's probably a reduction in risk appetite etc. but not sure I understand what residual hedge you chaps are talking about?

Reply
avatar
Unknown
admin
February 9, 2018 at 12:21 PM ×

Nico articulated my fear of selling vix. You would think this year will offer good opportunities to sell vol as a pocket of vol sellers was wiped, but with uncapped liability and a real potential that futures could go to 50, 60 or 80 or more, it is a hard thing to do.

Reply
avatar
Leftback
admin
February 9, 2018 at 12:59 PM ×

No disagreement there, Unknown, not buying the dip here, just betting on a decrease in fear today as weekly options expire and shorts take profits. Defined risk, small punt - that's what options are for!

There have been a series of great blog posts here on the balance sheet, and this one really makes the point succinctly, look at the graph of SOMHBOND v. DOW:

https://confoundedinterest.net/2018/02/08/fed-leaves-balance-sheet-unchanged-after-stock-massacre-the-last-time-as-dow-tanks-1033-points/

How are they going to continue QT? What a gigantic hole the Fed have dug for themselves…..

Reply
avatar
Leftback
admin
February 9, 2018 at 1:35 PM ×

O Canada!
https://www.statcan.gc.ca/eng/start

Shockingly bad employment report. Right on cue with a drop in crude oil. I know, noisy series, but still…???
Cue a firmer USD and a bid in Treasuries?

Reply
avatar
Leftback
admin
February 9, 2018 at 2:00 PM ×

Here come the vol sellers…. it was a decent overnight punt to fade extreme fear. Blood in the streets...
High percentage, decent risk/reward.

A good chance of a screaming squeeze today.

Reply
avatar
JohnL
admin
February 9, 2018 at 2:20 PM ×

I heard a rumour of some bloke, wearing a long overcoat with the collar popped, wandering about the Washington square arches, asking folkes if they had seen his Kevlar glovers. He was reported to be mumbling something about not having used them for so long that he may have to buy a new pair....was that you LB?

PS Denis G just told Tom Keen, on bbg radio, that he was short and moving shorter.....hhmmm

Reply
avatar
February 9, 2018 at 2:40 PM ×

Have we found the fraud? The XIV is only part of it I'm afraid.

PS, I know its a bit late for degrees...but you know, I've been busying at wishful thinking.

Reply
avatar
johno
admin
February 9, 2018 at 3:03 PM ×

Any of our Asia-based readers have a clue when Chinese stocks see end of WMP liquidations?

Overnight standing orders between 9.99-10.00 got filled in EURSEK and I woke up a richer man! Pleasant surprise!

Reply
avatar
Shawn
admin
February 9, 2018 at 3:22 PM ×

"Dr. Poloz....there's a Jean-Claude Trichet for you on line 3."

"Ok, I'll tell him you're not here."

Reply
avatar
Skr
admin
February 9, 2018 at 3:41 PM ×

Let's call a spade a spade here, this is a scalpers paradise, I know this is a macro blog, but any of the old school would kick the teeth in of the "equities is where the talent is" hell even the bots are predictable.
Sometimes you've got to release the beast!

Reply
avatar
Skr
admin
February 9, 2018 at 5:47 PM ×

All in the voice of Christopher walker (
((cough!)) strokes arm and fixes shirt) of course. And that smile...with just a little move of the head.

Reply
avatar
Leftback
admin
February 9, 2018 at 7:48 PM ×

We were out of the short vol trade at 9.34am today, just had a bad feeling. Sometimes making a small amount of money and getting out feels great. Especially on Fridays!

Reply
avatar
Polemic
admin
February 9, 2018 at 8:17 PM ×

Suffering from one of those feeling of having been so pleased wiht the last 2 weeks I now dont knwo what to do. Or rather I care a lot less.

My core feeling is that this isnt so much what they want us to believe 'INFLAYSHUN INNIT' but a bankg on schedule February psoitional wash out of all favorite trades. II know I bleat on about it veryyear about how markets come out of the blocks in Jan oney to get torn apart in Feb, but look. It just so fits!

We even had hte perennial 'Deutsche Bank shares falling' headline when I was going up the same skilift as last year. Deja vu or what?'

As expounded above .. bonds need to crack and this afternoon we saw them rally at last .. not a lot but the stresses on teh system re P?L finally showed through dispelling hthe idea that this is a bond AND equity dump - and before you start on about "well that was just a reaaction anticipating teh Fed responding to a slow down induced for stock dump" - that's rubbish. Liquidation of possitions with a smatetring of old fashioned safe haven ..

But that opens up the next question - what is safe haven? If the US treasury market is being doubted as the ultimate safe haven then what? It's carnage for USD. that's what and it's Zimbawean economics for Donlad trump, who, let's be honest has alwas run his buisnesses by promising big, borrrowing other peoples money bigger, and then blowing up leaing eth debtors with teh baby whilst he walks off with his paycheck.
Which is sort of what he's doing now. DT is PE'ing the US (Private equity).
Great if you can walk away with the money but not so good if you go Carillion on the US.

So that sthe disaster scenario.

But on the trading scenario we have seen an algo bloodbath. W ehave seen in the last 24hr a move form 'just a correction' to more 'of ohh jeeez' and e have had a reasonable bounce in stocks from 1.30 NY time.

I am watching this close with huge interest as if we close above 2600 spoos that may be it for now. With short term pain meted out and we can settle in for the longer biigger picture.

I ve put on some spivvy longs in equity indices athat i am happy to cut an dreverse omn new lows.






Reply
avatar
Skr
admin
February 9, 2018 at 10:32 PM ×

Good man POL, at least you know what it is to sack a lad/team at month end . But If Carlsberg did vix...

Reply
avatar