Some non-random observations post the volatility 'shock'

The volatility shock has now come. Whether it has already gone is another question. The following piece is a non-random list of observations, comments and open questions mostly in chart format.

a) Dang, that VIX beta to S&P is nasty!

b) The sell off is so far localized in widely traded S&P500 volatility instruments

c) Distribution of 1y forward returns implied by digital options repricing the left-hand tails (S&P 500 both at the same level on December 15th 2017 and February 8th 2018). This is what happens when portfolio managers must cover the tail options they discreetly sold.

d) But instruments tied closer to “economic” volatility are still not showing any signs of stress

e) Maybe this is just because a CDS was never meant to be a volatility hedge. Yet some people are still looking to the previous crisis instead of looking ahead.

f) Now don’t get me wrong, I think there are some fantastic opportunities to be short credit but buying it as a portfolio hedge is idiotic. The graph above tells you that the beta of equity is currently “infinite” relative to CDS making it a useless volatility hedge.

g) On the other hand, some telecom names might provide for some juicy opportunities in the relative value space between bonds and equities. Remember a credit position is nothing else than a short-put position. I would be comparing the implied volatility on CDS vs. the implied volatility of options.

h) Are we about to see minimum volatility stocks make another run at outperforming the broad market after underperforming for 2 years? Relative fund flow suggests it might. This has historically been concurrent with a period of negative equity returns

i) The average volatility weighted US portfolio is taking a serious hit (h/t to George Adcock aka “Elmo” for pointing this out). On an annualized basis, the latest move seriously hurts. I would expect this to curtail risk taking capacity for a while, especially in the equity portion of portfolios.

j) Now as George points out, that money might be moving towards real assets. I’m not convinced, but I’m monitoring nonetheless.

k) To conclude, what we’ve witnessed this week is a precursor of things to come: when flows “reverse” in a market place increasingly dominated by price insensitive actors (so called “passive” strategies) prices don’t adjust linearly, they gap.