In his latest daily note, which does a fantastic job of exploring what the macro "big picture" looks like at this moment (more on that below), RBC's head of cross-asset strat Charlie McElligott focuses on one of his favorite topics: random outlier moves in asset volatility and, specifically, the crowding of traders behind them. And with the VIX sliding below 10 yesterday for the first time since February 2007...

... and likely set to repeat that achievement today ahead of AAPL's earnings, the RBC analyst does report some notable developments across the vol space, namely that once again everyone is piling into short inverse VIX ETFs, everyone perhaps also including pension funds.

Of particular note, McElligott writes (see below fore details) that:

" short vol' isn't just an institutional trade anymore, it's massive with retail as evidenced by the shares outstanding in the various VIX ETNs . FT highlighted over the weekend that ‘short interest’ in VXX has actually outpaced creation of new shares in VXX this years, which is indicative of this growing retail demand for the ‘strategy.’ Currently per my stock loan team, VXX short utilization spiked to an insane 95% yesterday (% of the ‘free shares’ being used to short)."

From the latest Big Picture by RBC's Charlie McElligott

SPX VOL CRUSH CONTINUES: Yesterday we hit a ‘9’ handle in spot VIX, the lowest level in implied vol since ‘08. The reasons are many.

1) The slow-and-grinding’ drag higher’ via options-market mechanics is a contributing factor. 2400 as a 'gravitational pull' in S&P index is a real phenomenon (both from 'short gamma' and 'deltas' perspective), especially with $42.5B of notional calls in weeklies across SPX, SPY and futures out through May expiration per our Andrew Ramsey.

2) Clearly ‘earnings growth’ an ENORMOUS input right now. The general equities-narrative has turned from one purely driven by the ‘direction of rates’ or ‘inflation-expectations’ experienced over the past 2 years into one where investors are focusing on analysts raising full-year EPS forecasts over the course of Q1, which is, by recent standards, unheard of.

The SPX long-term model in Quant-Insight now shows ‘1y forward earnings’ effectively as the largest ‘positive’ macro factor sensitivity to SPX price:



3) Sadly, I also think the VIX move continues to evidence the enormous crowding of 'short vol' strategies and trades in the market. 'short vol' isn't just an institutional trade anymore, it's massive with retail as evidenced by the shares outstanding in the various VIX ETNs. FT highlighted over the weekend that ‘short interest’ in VXX has actually outpaced creation of new shares in VXX this years, which is indicative of this growing retail demand for the ‘strategy.’ Currently per my stock loan team, VXX short utilization spiked to an insane 95% yesterday (% of the ‘free shares’ being used to short).

An expression of this same ‘short vol’ trade is evidenced by the growth in ‘vol writing’ funds’ AUM. DB did some work here in a recent report and discovered upwards of $45B of AUM amongst this growing universe, up from $10B pre-crisis. And you might recall me highlighting the AWESOMENESS of various pension funds crowding into ‘put-write’ overlays last Summer (see link below) on top of the consistent popularity of ‘call-write’ funds too, so this fits the story. Consultants have an easy job selling the ‘earn premium plus mute your volatility’ pitch, even if that’s not how it actually ‘works out’ in real life. This article last Fall from Pensions & Investments (“Funds Go Exotic with Put-Write Options to Stem Volatility”) is probably a good place to start driving yourself crazy http://bit.ly/2pPRAAz:

“Mr. Tirado said put-write options are becoming popular with pension funds at a time when their overall equity portfolio can be too risky and their bond portfolio isn't providing enough income in a continuing low-rate environment. “Pension funds are between a rock and a hard place,” Mr. Tirado said. “Low funding, risky assets, both have exposure to downside risk. In this, they've constructed a strategy to transfer risk.” Russell"s Mr. Hellekson said the strategy gives investors “a way to get defensive equity, to reach for carry when the markets are going sideways. That's attractive for some folks.” The carry comes from the cash premium from the put option when sold. “If markets go sideways, they still get income; they can't lose,” he said.”

And of course a discussion on ‘short vol’ can’t be had without discussing the scale of ‘negative convexity’ strategies in the market place—thus my consistent focus on ‘risk parity’ funds as an example of this universe.

As per the post GFC-period where the intent of quantitative easing has been to artificially suppress financial asset volatility through ZIRP, NIRP and LSAP’s, the negative correlation of stocks and bonds has allowed for outsized returns in strategies which tactically allocate ‘risk’ based upon backward-looking volatility measures across assets, but all tied largely back into the ‘pinning’ of rates (yes, the construct changes as rates are again being allowed to move increasingly via market forces….but that’s an email for a different day!). In the meantime, we are looking at a universe where between risk-parity, risk-control and vol-target funds, we’re likely talking upwards of $1.0 to $1.5 TRILLION of AUM…and that’S without including the opaque structured-product universe.

Everybody is profiting from the trade so its popularity continues to grow, until it inevitably ‘blows up’ on something. The ‘sad’ thing is that it likely won’t even require a ‘left tail’ event with such asymmetry in the trade right now.