A dangerous trade that reminds experts of the 1987 market crash is riskier than ever
The net position of investment products that track the CBOE Volatility Index — or VIX — has slipped into short territory for just the second time in history.
Goldman Sachs is worried about what might happen to the market if a spike in volatility ever causes this trade to unwind.
The situation is arguably more dire than the last time traders were net short, because the stock market has gone that much longer without a major reckoning.
Despite repeated warnings of a painful reckoning, traders can’t seem to wean themselves off one of the market’s riskiest investment strategies.
The trade in question is the shorting of stock market volatility using exchange-traded products (ETPs), and the situation has reached an extreme only seen once before in history. The net position of ETPs that track the CBOE Volatility Index — or VIX — has become short for just the second time in their eight-year history, according to data compiled by the equity derivatives team at Goldman Sachs.
One possible interpretation of this is that investors are assuming too much risk. But Goldman is more worried about how exposed these positions will be if the VIX spikes unexpectedly — something that could cause traders to quickly reverse positions.
Regardless of how you look at it, this is a tenuous situation for markets. And it’s one that’s arguably more dire than the last time the ETPs were net short, simply because stocks have gone that much longer without the type of earth-shattering market event that could cause such an unwind.
The chart below shows the dynamic in action, with the line representing the vega outstanding on VIX futures, which is defined as an option’s sensitivity to changes in price swings on the underlying asset. Simply summarized, the VIX ETP market currently has …read more
Source:: Business Insider