Most people think that volatility comes in spikes (if they think about volatility at all). But volatility begets volatility and usually comes in waves, not isolated spikes. This makes the recent action that much more interesting because we have seen increased volume in the VIX based products with each of the “spikes” over the last two weeks. It suggests that many are using the increases in the VIX and VXX to sell more volatility.
The short volatility play has been the bread and butter of profit for most hedge funds and others for the last six years or so. So much like equity “dip buying” these players are Volatility Spike Sellers.
What that means is that the short volatility position is getting bigger. And when we have a proper sell-off in equities, which we will, the wave of volatility could be quite significant. Those that are short volatility will be forced to cover at some point, and that can have cascade effects in a variety of places, including pushing into the Indexes and areas like risk parity. So while it tempting to sell every volatility spike, it is not wise. There are better ways to play these moves, even if it is hedged directional bets in things like the VXX – a VXX put vertical for instance.