Macro Wrap – $VXX, The Tail That Wags the Dog

by Enis February 26, 2013 7:59 am • Commentary

This week’s move in the VIX is certainly historic.  As Bill Luby wrote at his VIX and More blog yesterday, it was the 11th largest one day VIX spike in the history of the VIX (almost 25 years of data).  The past week of price action is even more notable though, as the VIX closed at 12.31 on Feb 19th, and closed at 18.99 yesterday, a whopping 50%+ rally in less than a week.

One novel characteristic of the current vol market relative to history, though, is the large impact that trading in volatility ETFs, primarily VXX, has on the VIX itself.  Yesterday’s VXX volume was the highest in its history, by almost a factor of 2:

VXX 1 year chart with volume, Courtesy of Bloomberg
VXX 1 year chart with volume, Courtesy of Bloomberg

The volume in the VXX almost reached 100 million shares yesterday, shown in the lower panel.  A good portion of that volume was surely short covering, as traders panicked when VIX spot moved above front month VIX futures.

But another reason why the short covering aspect of the story is important is because of the steady increase in short interest over the past year:

VXX shares shorted, 1 year chart, Courtesy of Bloomberg
VXX shares shorted, 2 year chart, Courtesy of Bloomberg

In the past 2 years, VXX short interest only declined during the volatile period in the fall of 2011.  But since February 2012, the VIX has rarely traded above 20, and has resulted in an unmitigated increase in traders shorting the VIX.  The chart above is a bit deceiving because the VXX price is lower now, so in notional terms, the increase in short interest is more like 25-50% higher than it had been 6 or 12 months ago.  Yet, that’s a substantial increase, and crucially, the recent VXX spike might be the one to finally change the Pavlovian reaction of traders to sell VXX on every market dip.

This type of VIX “kickoff” event usually means a new, higher range for the VIX for at least the next couple of months.  I will be watching the price action and volume in the VXX very closely.  Traders’ positioning in the ETF has been and will be a major driver for the VIX, and potentially even the broader market, going forward.

Markets overnight:

  • Asian equity markets followed the U.S. lower, with most markets trading lower by more than 1%.  Japan was the weakest after the strength in the yen in the U.S. session.
  • European equity markets opened down around 2% on average (led by Italy down 4%), and have traded in a tight range ever since the open.  SPX futures are up 0.3% in the pre-market.
  • Currency markets have been quite tame after yesterday’s volatility.  Commodities are mostly lower with the exception of precious metals, and Treasuries are lower too.
  • Bernanke speaks in front of Congress at 10:00 am EST.  Italian politicians also could provide headlines intraday as they hold press conferences.
  • Case Shiller home price data released at 9:00 am EST.  Richmond Fed, Consumer Confidence, and New Home Sales out at 10:00 am.