Assault On The VIX: Upside Appears Imminent As Reddit WallStreetBets And Retail Investors Preparing Another Short Squeeze On The VIX Complex
Long/Short Equity, Value, Contrarian, Bonds
Seeking Alpha Analyst Since 2016
The author is a 25+ year market veteran who has worked on both the buy and sell sides in research, trading, investment banking and fund management.
Summary
- Reddit WallStreetBets discussions are focusing on a VIX short squeeze to disrupt the long time favorite hedge fund and CTA short VIX yield roll positioning play.
- Retail investors across the message board have been emboldened by their recent successes raising pricing in the cannabis sector, squeezing shorts in Gamestop, other heavily shorted names and silver.
- Collaboration and coordination among previously unaffiliated online investor groups are impacting markets and damaging some hedge funds due to their unorthodox strategies.
After a rather long hiatus, I thought it appropriate to chime in at present as we may soon be seeing another debacle in the volatility complex. I had almost given up hope that volatility could play a meaningful part in today’s casino-like equity markets as it has long been manipulated and controlled by large hedge funds and our own Federal Reserve. I think it safe to say that volatility manipulation through Fed interest rate control has been the driving factor behind equity performance for several years now as fundamentals and valuations have gone by the wayside.
In the very short term, various market gurus think they may have found the next target that the WallStreetBets subreddit, Robinhooders and those retail investors, who collectively have formed a loose alliance, are aiming their disdain and capital towards in the next phase of their quest to topple some of the Wall Street old guard. Their asset class of interest is the Cboe Volatility Index complex. The means for disrupting the volatility complex is through VIX options and futures, as well as the usual lineup of heavily traded volatility funds, UVXY - ProShares Ultra VIX Short-Term Futures ETF, VXX - iPath S&P 500 VIX Short-Term Futures ETN, and VIXY - ProShares VIX Short-Term Futures ETF, all of which are widely available and tradable through many online trading platforms.
Short positioning in VIX futures has finally risen to the level where it used to be before the Covid-19 pandemic. This has long been a "smart money" trade ever since the market's realization that the Fed would be backstopping the entire U.S. economy through QE interest rate control. Post-Covid, the market believes the Fed has no alternative but to continue "printing" money to feed the liquidity addiction that underlies the near zero rate environment. This is the basis for the ever increasing equity/asset pricing inflation through continuous margin debt expansion that market observers see with equity index levels that recently rarely decline. It's the reason that every dip is bought with the belief that there will always be more liquidity coming.
The WSB retail crowd appears to believe the time is near to squeeze the short VIX speculative positioning that is now near extreme levels. According to Morgan Stanley's Quantitative and Derivatives Strategy group, VIX exchange traded products have seen record inflows over the past week which has led to increasing VIX futures longs. While this doesn't necessarily mean that a squeeze is coming tomorrow, MS theorizes that the environment is ripe for this sort of scenario to play out in the near term as retail investors are more likely to hold their positions as volatility rises.
As hedge funds such as Gabe Plotkin’s Melvin Capital have come to learn, an assault by retail investors is something to be taken seriously. Melvin was rescued to the tune of over $2.75 billion by Point72 and Citadel after being pushed to the brink via its GameStop short. So, will this be another chapter in the battle of underdog retail investors versus the Wall Street Goliaths? Time will tell, but if recent history is an indicator, the execution of the plan will be swift and decisive, and we could start seeing liquidity issues among the vulnerable in the hedge fund industry over the next few weeks.
In the near term, UVXY, VXX and VIXY are likely to see upside as VIX futures and options are poised to rise. As of this moment, Tuesday February 16 at 1:30pm, the VIX has already climbed back above 21 on almost no S&P 500 downside. The VIX has been particularly sensitive lately to minor moves in the S&P, and it is regularly slightly positive even with the index rising marginally. Market complacency has rarely been higher than what we are currently experiencing. The equity market has been overstretched on valuations, technicals and momentum since the beginning of February. The next week or two should see significant movement upwards in the VIX.
Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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