"It's incredible how short the memory of the market is," Spitznagel says. "In some areas there is an unprecedented level of complacency."
Betting on markets remaining placid — shorting volatility, in trader parlance — has been a big feature of the post-crisis market environment. There are many ways to do so, but one of the easiest is too short futures contracts linked to the Vix, an index that captures the short-term volatility of the S&P 500, implied by options.
The attraction is obvious. Vix futures are usually in "contango", jargon for when near-term contracts are cheaper than longer-term ones. After all, the distant future is more uncertain than tomorrow.
By shorting longer-term Vix futures and waiting for them to expire at a lower price of actual, realised volatility, investors can make a bundle.
Profits from this strategy vary over time. But with realised US stock market volatility comfortably below the Vix, Société Générale estimates that the shape of the Vix curve means that investors are currently pocketing a monthly 8 per cent yield by shorting the index.
"When seen against the backdrop of the aggressive hunt for yield triggered by the great central bank retreat, the new all-time record short positioning in Vix futures perhaps does not come as a surprise," Arthur van Slooten, a SocGen strategist, wrote in a recent note.
However, this is akin to selling hurricane insurance after a period of balmy weather. When a storm finally does strike, the premiums collected may not be enough to compensate for the damage caused.
For example, XIV, a short-Vix exchange-traded note popular with day traders, returned over 1,000 per cent in 2011-2017 but was wiped out in just one torrid day on February 5 2018.
Because of the structure of XIV and a few similar funds, when turbulence began to mount in early February they were mechanically forced to buy more Vix contracts, triggering a feedback loop that ultimately ripped them apart and sent shockwaves rippling through the broader stock market.
"Market developments on 5 February were another illustration of how synthetic leveraged structures can create and amplify market jumps, even if the core players themselves are relatively small," the Bank for International Settlements said in its postmortem of the episode.
Some investors are therefore worried about the signal sent by the renewed build-up in short-Vix futures.
"When everyone is pointing in the same direction, like sheep, it is normally the wrong direction," argues Alan Miller, chief investment officer of SCM, a London investment manager. "A low Vix index should make you nervous rather than complacent."
Nonetheless, analysts stress that it should not be a cause for panic. Firstly, the net positioning is so deeply short, mostly because of slumping "long" bets on the Vix. The gross number of short positions is elevated, but still comfortably below 2017 levels.
Secondly, the heft of Vix-linked funds has shrunk significantly. At the moment, they are actually net long volatility.
"We don't have the potential feedback loop we had before," says Benjamin Clerget, a volatility-focused fund manager at BTG Pactual.
Volatility also has a tendency to disappear for long bouts in the post-crisis period, and when it returns it is often with a bang. However, the Vix index is currently only somewhat below its post-crisis average of about 17 per cent, and well above the record low of 9.2 per cent touched in late 2017. That implies that it could sink further.
On the other hand, the strategies that have sprung up around the Vix are just one part of a broader, vibrant but very complex volatility-trading industry, which alarms some observers, and may help explain why markets seem to be characterised by longer calm stretches followed by more violent ruptures.
The problem is timing these bursts of turbulence, given the risks involved in both going long and short volatility, Clerget points out.
"One day, long volatility will be the trade again, but people are always too early," he said.
"If you're short vol you make money but eventually die. But if you're long vol you die before you make money."
Written by: Robin Wigglesworth
© Financial Times
