Levered/Inverse ETPs. Levered and inverse VIX ETPs' assets under management have reached all-time highs at just under $2.5 billion. The daily rebalancing flows required to maintain the desired exposure of the ETPs has reached record highs. VIX ETPs exacerbate moves, buying as volatility rises and selling as volatility falls.
Disappearing Liquidity. Substantial flows into VIX products did not exist before 2012. Today, however, when hedge funds and CTAs cut or modify their positioning, it often occurs at the same time as VIX flows, which causes there to be an excessive amount of positions that need to be exited at the same time. We have witnessed disappearing liquidity in VIX futures/options during volatile days.
VIX as a Universal Hedge. Market participants are increasingly using the VIX as their hedging mechanism. This includes credit and macro fund managers, as well as other hedge funds. Rather than buying, holding, and rolling exposure, the ease of the VIX market has caused players to heavily and quickly buy or sell volatility. This has caused volatility to become more reactive to market events, such as headlines, broker statements, and traders' views. Instead of being priced on realized volatility plus a risk premium, volatility is trading on flows, intuition, and speculation.
Speaking to the reactivity and focus on the VIX market, we have witnessed a number of trading days where the movement of the VIX was not justified by the magnitude of the S&P 500. One example is Oct. 15, in which SPX opened down 0.19% but the VIX opened up 3.57 volatility points (+15.66%), a percentage move 439 times the size of the SPX move, showing that the VIX may be where the action is occurring. In fact, it has appeared that the tail has been wagging the dog on eventful days as the VIX actually impacts SPX. On the back of news, there has been a flood of demand for VIX futures. The rise in the level of the VIX then pushes SPX lower as traders react to the higher VIX level.
VIX Universe Volume. VIX trading has skyrocketed, especially in comparison to SPX. The vega volume trading through VIX futures, options and ETPs far outpaces that of SPX options volume. This is especially true of months during which volatility increases, such as January and October 2014. If OTC volume was included, this imbalance would likely be multiplied. This relationship is not true of other indexes, such as EuroStoxx vs. VSTOXX. According to Barclays, the volume of vega exposure flowing through VIX futures, options and ETPs daily spiked to about $1.1 billion in mid-October, whereas the rise in listed SPX and SPY volume was to about $300 million vega per day.
Overnight VIX Futures. The recent advent of overnight VIX futures trading has the potential to incite a panic in the rest of the market, given its lower degree of liquidity, if an event were to occur overnight and VIX futures were bid up into a thin overnight market.
The size, market focus, and systematic flows of the VIX product universe, contribute to the VIX universe's potential to either directly be, or to intensify, the cause of liquidity drying up, thereby exacerbating market gyrations. October 2014 was a historic period with respect to how rapidly and sharply volatility spiked and subsequently fell. The movements in December 2014 were further evidence. There appears to be gap risk in the VIX, perhaps in both directions. Given a large move up in the VIX, the rest of the market might take its cues and sell off even more sharply. Additionally, the increased amount of VIX trading has led to a higher turnover of volatility, rather than buying and holding, which could further exacerbate a move in either direction.