Over the past month, the topic of "someone" or "someones" rushing to allocate capital toward expectations of a future volatility surge using such volatility derivatives as VXX, has surfaced on several occasions. The first time was three weeks ago when Tom McClellan pointed out that "VIX futures ETF extremely popular now. Can this possibly end well"...
... when he pointed out something that on the surface was counterintuitive, using his post from February 18 when the market has just reached its most recent selloff bottom:
If VXX worked like other ETFs, then as the SP500 falls and the VIX rises, more investors would chase after it and drive up the total number of shares outstanding in VXX. But instead we see the opposite behavior in the chart above. Right now, VXX shares outstanding are at one of the lowest readings of the past couple of years [ZH: this was written on February 18], and such low readings are reliably associated with meaningful price bottoms for the SP500. So rather than seeing the “hot money” piling into VXX as the VIX rises, its shares outstanding data acts more like a depiction of the “smart money”.
By the same token, XIV’s share price has fallen in 2016 as the VIX has risen, and investors have responded by pouring more money into XIV and thus driving up is number of shares outstanding:
Effectively McCleland used the collapse in VIX shares outstanding in the February rout as an indicator that the seling had exhausted itself. He was right. Two months later, it was the surge in VXX shares that caused concern for McClellan.
He was not alone.
At virtually the same time, none other than Goldman, which incidentally was urging clients to sell volatility, made the same disturbing observation saying that "Our view that the VIX may remain low in the near term is at odds with the VIX ETP market, as investors seem to be pouring money into levered long VIX ETPs."
Goldman made several more notable observations:
As the VIX has declined, the demand for VIX ETPs that benefit from a rise in market volatility remains strong, in particular double-levered VIX ETPs such as UVXY and TVIX
Yet oddly enough, the price for ETPs such as the VIX remained disconnected from the demand, leading to a record surge in shares outstanding and thus market cap. Goldman observed that as well, adding that vega exposure had also shot up to never before seen levels:
In April 2016, the market cap of the UVXY topped $1bn for the first time and vega exposure on the UVXY remains near an all-time high at around 120 million (Exhibit 1). The markets two most popular double levered longs are the UVXY and the TVIX. Their combined vega exposure recently stood at around 190 million vega, about twice the vega in single-levered long products such as VXX and VIXY.
Providing some more color on vega, Goldman added that Vega exposure on longs has tripled since February 11: The total amount of vega exposure across four popular long VIX ETPs (VXX, VIXY, UVXY, TVIX) has tripled since February 11 and recently stood at ~290 million, a record high.
Goldman summarized its finding saying that while "long ETP exposure has been growing, the appetite for inverse VIX ETPs, which benefit from declines in volatility such as the XIV and SVXY, has been muted, with vega exposure remaining range-bound in recent weeks. That’s surprising, since the benchmark index which these underliers track (SPVXSPI) is up 73% since the market low on February 11 and investors often follow performance!"
Only in this case investors were not only not chasing performance, as they traditionally do, they have been betting on a reversal in the market's upward direction and thus, an explosion in volatility. And they have been doing so in massive - relative to the recent past - amounts.
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This was three weeks ago. Today we decided to update on the number of shares outstanding, and thus both the capital inflow into and the vega, of the two most popular inverse volatility derivative products, the S&P 500 VIX Short-term Futures ETN (VXX) and Ultra VIX Short-Term Futures (UVXY). This is what we found.
We are confident that if Goldman was surprised how many investors in the VIX ETP market disagreed with Goldman's 'low vol' call three weeks ago, it will be absolutely shocked now. Because what the charts show is that someone really wants this market to crash, and is putting their money where their mouth is.
Ironically, that is precisely what Goldman - until recently very bullish on stocks - warned just this weekend may very well happen.