‘The Risk Remains Large’: Updating The VIX ETP ‘Doom Loop’

Ok, I think this is as good a time as any to update you on where this market stands in terms of what we’ve variously dubbed the “nightmare loop” or, if you like, the “doom loop.”

Generally speaking, what we’re talking about when we talk about “feedback loops” in this context is the potential for a VIX spike to trigger a panicked rebalance by inverse and levered VIX ETPs that would in turn exacerbate said spike and eventually force vol. control funds and CTAs to deleverage into a falling market. The following quote from JPMorgan’s own “Gandalf” (Marko Kolanovic) is obligatory for posts on this topic:

Given the low starting point of the VIX, these strategies are at risk of catastrophic losses. For some strategies, this would happen if the VIX increases from ~10 to only ~20 (not far from the historical average level for VIX). While historically such an increase never happened, we think that this time may be different and sudden increases of that magnitude are possible. One scenario would be of e.g. VIX increasing from ~10 to ~15, followed by a collapse in liquidity given the market’s knowledge that certain structures need to cover short positions.

If you need a refresher on this, you’re encouraged to see the following posts (in descending order, most recent at the top):

  • The Doom Loop Is Back: ‘VIX ETP Risk’ Hits All-Time High
  • The ‘Doom Loop’: How VIX ETPs Exacerbated Last Week’s Vol. Spike
  • A Nightmare On Wall Street – Updating The Feedback Doom Loop (Again)
  • A Nightmare On Wall Street – Updating The Feedback Doom Loop
  • Investigating The Market’s “Nightmare Scenario”
  • The last time we checked in on this was on September 17 (first post in the list above), when we noted that according to Deutsche Bank, the potential impact of VIX ETPs had hit a new high as VIX ETP providers would need to buy around $150mm vega on a hypothetical 5-vol spike in the VIX futures curve. That figure represented a near doubling since mid-July on inflows to short VIX ETPs. Ultimately, the rebalance reached $180 million last month.

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    Author: Travis Esquivel

    Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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