Insights

Follow up for “Can you answer this question?”

Posted by Michael Mescher on 11 Aug, 2017

From 10:21 AM:

Just a quick note to follow up on our piece from Monday entitled “Can you answer this question?”:

As I write this, the near dated VIX futures term structure looks like this:

symbol price
VIX 14.27
UX1 (Aug VIX future) 13.9
UX2 (Sep VIX future) 14.15

We have spent the last few months educating investors on volatility and the hidden risks in the market. Today’s market is what it looks like when those hidden risks start to become realized. While this market may be painful for some, this has the potential to compound quickly.

As the VIX futures term structure approaches flat, many investors who play the carry trade have now lost their edge. They are faced with the tough question of holding the position and waiting for a quick reversion (a behavior that has been conditioned by the market for weeks), or cutting the losses now.

We suggest keeping an eye on the VIX – UX1 – UX2 spreads. If UX1 trades above UX2 near the close we would expect another wave of pain.

Despite what we have seen over the past 4 months, it is important to remember that the market is far from bulletproof.

Risk management is of paramount importance in all environments.

Don’t worry though…if you ever forget this rule, the market will remind you.

At 4:50 PM:

Earlier today, we warned that if the VIX curve went inverted, another wave of pain would compound quickly. This underscores our note from Monday that highlighted a lack of liquidity in a stress situation.

Those concerns were realized, and an 8% rally in volatility ensued:

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