PODCAST:Odd Lots
TITLE:Why the Short Volatility Trade Is Back and Bigger Than Ever
DATE:2024-01-29 00:00:00
URL:
MODEL:gpt-4-gizmo
In the episode of Odd Lots titled "Why the Short Volatility Trade Is Back and Bigger Than Ever," hosts Tracy Alloway and Joe Weisenthal explore the resurgence of shorting volatility in financial markets. They discuss this trend with Chris Sidio, co-CIO of Ambrose Group, who provides insights into the dynamics and implications of short volatility strategies. Shorting volatility, essentially betting on market stability, has grown significantly, with the net short Vega notional currently twice as high as before the 2018 Volmageddon event. Moreover, assets under management (AUM) in derivative income-generating funds have increased over tenfold since January 2018, despite the apparent risks and past market disruptions associated with such strategies.
The conversation highlights how, after the 2008 financial crisis, low-interest rates and central bank actions led investors to seek yield through short volatility trades. However, the environment has changed, with rates rising and more potential for market-disruptive events, yet the appeal of short volatility remains strong. Sidio explains that the trade wins most of the time, which can lead to complacency and poor risk management practices among investors. Despite the potential for significant losses, the strategy's past success and the increased availability of shorter-dated options have fueled its popularity.
Market makers play a crucial role in the ecosystem, with their hedging activities potentially exacerbating market movements during high-volatility events. The concentration of market-making activities among a few key players, combined with the increased trading of options, raises concerns about market stability. Sidio also discusses how institutions are increasingly participating in these short volatility strategies, driven by the desire to enhance returns in a low-yield environment and the availability of more trading tenors.
Despite the potential risks, Sidio argues that a significant market event that tests these strategies' resilience has yet to occur, maintaining investor interest in short volatility trades. The episode sheds light on the complex dynamics of volatility trading and its implications for financial markets, emphasizing the need for caution and better risk management practices among investors engaging in these strategies.
