Views From the Floor – Is VIX the Next Gamestop?

The sudden interest from retail day-traders in levered products focused on the volatility index has some investors worried. But is the VIX really the next Gamestop?


Despite equity euphoria, investors need to keep a weather eye on the big risk – inflation – and tilt their portfolios to match. In our view, this means seeking out the relative value available in the UK, Europe and Asia.
 

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VIX: the Next Gamestop?

There has been some concern that the attention of retail day-traders has moved away from single name stocks, and into levered exchanged traded products (‘ETPs’) focused on the CBOE Volatility Index (‘VIX’). Indeed, Morgan Stanley has highlighted the increased activity in the UVXY ETF, where Open Interest in call options has spiked in recent weeks (Figure 1).

Despite this increasing attention from retail day traders, the VIX is a long way from becoming another Gamestop, in our view.

While on first examination, the number of contracts that ETPs would need to buy to hedge a 1-point move in the VIX has reached the higher end of the few years’ range (Figure 2), this ignores two relevant features. First, a 1-point move in the VIX is not equally likely through time: instead, it may be preferable to consider how much buying would be required to hedge moves of a given standard deviation, as this can better account for the time-varying volatility (heteroskedasticity) of volatility. The second consideration is perspective: it has been three years since the VIX spike of early February 2018, which extinguished the last great wave of retail interest in inverse- and highly-levered VIX products. Figure 3 shows the importance of a longer dataset: while the number of contracts required to produce 1-, 2- and 5-sigma moves has recently increased, it is still towards the lower end of the historical range, largely due to the reduced assets in the space.

This is not to say that investors should not be wary. As we said right at the beginning, open interest in levered VIX ETP options has already increased markedly in 2021, and is an important data point to monitor. In 2018, it took sudden and severe losses to take retail investors away from trading the VIX, and though many traders are currently losing option premiums, the hedging conditions seen in 2018 have not yet been reached in the levered ETP or options markets. For months, even years, preceding February 2018, the stage was set but there was no melt-up of the VIX. We still have some way to go before we see VIX-mageddon.

 

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Source: Man Group, as of 25 February 2021.

 

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Source: Man Group; as of 25 February 2021.

 

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Source: Man Group; as of 25 February 2021.

US Stimulus: How Much Is Too Much?

Both former Treasury Secretary Lawrence Summers and former IMF Chief Economist Olivier Blanchard have weighed in to suggest that the US stimulus bill risks overheating the economy, with the former likening it to “managing the economy with the accelerator more on the floor that any time in peacetime history”.

As if to confirm our suspicions that this debate may run for a while, Goldman Sachs estimates that the effect of the stimulus will be more muted, factoring in an overall estimated spend of USD1.5 trillion plus an annual USD75 billion infrastructure spend later in 2021. Crucially, Goldman Sachs argues that since this spending will be spread over time, rather than concentrated now, it roughly matches their estimate of the current output gap at between 5-6% of GDP – and thus doesn’t present an inflationary risk.

We’ve previously highlighted a key aspect of the debate which bears re-examination. The coronavirus pandemic has been marked by the fact that supply is just as constrained as demand, due to the need for lockdown measures to control the spread of the virus. Thus, while the spending may match the output gap fairly well, constricted supply chains may be unable to match even a small increase in demand until coronavirus restrictions are lifted.

Until vaccine rollouts become more widespread, it is perfectly possible that the short-term aspects of the US stimulus bill exacerbate the inflationary pressures that we have already seen in raw materials (Figure 4).

 

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Source: Bloomberg; as of 25 February 2021.

With contribution from: Jonathan Nye (Head of Investment Risk, Man AHL and Man Solutions) and Pierre-Henri Flamand (CIO Emeritus and Senior Investment Advisor, Man GLG).