Maneesh Deshpande who is a Managing Director from Barclays gave an excellent presentation titled The Shifting Landscape of Volatility Products: Who is Doing What and Why, and What Should You Do About It?
He began by reviewing the three stages of VIX futures growth since their introduction in 2004. The first stage occurred from 2004 to 2009. During this period VIX futures were going through the introductory and acceptance phase as a tradable asset. The second growth stage began in 2009 when the introduction of VIX ETPs and ran through 2012. Most recently the increase in VIX futures volume has been driven by continued money flow into VIX ETPs and increased trading in VIX options.
After talking about VIX futures growth Deshpande discussed the areas of demand for volatility trading. He cited that traditional volatility traders that were involved in SPX options before the introduction of VIX derivatives are one source of demand. An area that developed around VIX trading was variable annuity products that created to target volatility levels. After 2008 there was an increase in demand for tail risk funds and an increase in assets under management for the funds. Finally the creation of VIX exchange traded products along with an increase in demand for VIX call options has recently fueled further growth in volatility trading. All of this extra demand has resulted in there actually being more Vega traded through the use of VIX derivatives than through trading in options on the SPX and SPY exchange traded funds.
The source of volatility supply has shifted from floor brokers and professional traders to registered investment advisors and non-commercial traders. This may be contributing to what Deshpande refers to as a potential air pocket in the 20’s for VIX trading. This risk of an ‘air pocket’ above the 20’s may be emerging where short volatility players may not be hedged for a spike in that range. The result could be short covering with a second leg to the upside if any crises were to extend beyond the initial spike. He also noted that there seems to be an increase in the number of traders playing the current range that VIX has established.
A trend that was discussed and got a lot of interest from attendees was that VIX ETPs tend to see inflows in low volatility periods and outflows when there are volatility spikes. This is what he called the emergence of systematic volatility selling on spikes. The curve now looks more like a U than the complete inversion that use to result from a volatility event.
Finally, he pointed out that over the past few months the supply of volatility has increased while the curve of volatility futures is less steep which has resulted in decreased the profitability of volatility roll down strategies.