LJM Fund Closes Due to Vol Bet; Markets’ Derivatives Knowledge; ‘The Tail Grabbed the Dog’

Feb 9, 2018

Observations & Insight

The Spread – Week of 2/5 – 2/9
This is a bit of an early edition of our weekly options news recap as snow has blanketed Chicago and will continue to fall for the next few days. As another result of being Chicago-based, there is a built in affinity for the Bulls and the Bears. Well, bears are having more fun at the expense of bulls as a crazy trading week altered recent market norms. (This sports metaphor falls apart pretty quickly…)

Watch the video and read the stories referenced here »


February Options Volumes Thus Far – Via OCC
(Click for larger image)


The VIX Can’t Cause Vol – Cboe’s View on Volatility ETPs
Spencer Doar – JLN
As volatility began to surge in February, and then exploded on the fifth of the month, exchange traded products (ETPs) that shorted or provided inverse exposure to VIX futures came under fire.

****SD: In case you missed it yesterday.

Lead Stories

Hedge fund crashes after wrong-way volatility trade
Leslie Picker – CNBC
The e-mail arrived in clients’ inboxes shortly after the market opened on Tuesday: “LJM strategies have suffered significant losses.”
LJM Partners, a Chicago-based hedge fund with about half a billion dollars in assets, pinpointed the damage on spiking volatility, a trade that has claimed more than one scalp in the last few trading days. Their mutual fund, known as the LJM Preservation and Growth Fund, collapsed by 82 percent over the last week and was closed to new capital on Wednesday.

Markets Show What They Don’t Know About Derivatives; An unvirtuous cycle of new money is pushing prices higher in a chase for returns.
Dean Curnutt – Bloomberg
The breathtaking stock market meltdown this week provides a valuable case study of the interaction of market risk, derivative product innovation and the unwinding of trades that became vastly crowded as a result of their earlier success.

Vix futures co-inventor: ‘the tail grabbed the dog’ this week
Miles Johnson – Financial Times
Vast speculative trading in derivatives tied to stock market volatility is dangerously scrambling key inputs used for risk management by banks, one of the original inventors of so-called Vix futures contracts has warned.
Sandy Rattray, who jointly devised the formula to trade futures contracts tied to the Vix back in 2003 when working at Goldman Sachs, said products that allow investors to trade volatility could be creating a “circular system” of measuring risk in financial markets.

Stop Blaming VIX For The Stock Market Correction
Peter Tchir – Forbes
As pundits look for things to blame, many have fixated on the VIX linked ETFs and ETNs. I am very familiar with them. I wrote about the “Golden Goose” strategy of buying the short VIX funds almost a year ago. I also wrote about the risk of an Acceleration Event in “What Could Cause VIX to Erupt?”

Battered Options Market Chokes on the Shift to a Tech-Led Selloff
Luke Kawa – Bloomberg
The tenor of this selloff is shifting. But either no one’s told the options market, or significantly strained trading conditions have left it unable to digest this meal

VIX Options Are Finally Catching Up to This Market’s VIX Levels
Joanna Ossinger – Bloomberg
Trading in the most popular options on the Cboe Volatility Index is starting to catch up to reality.
The top four most-active VIX options Thursday included February 40 calls, 30 calls and 45 calls, levels in the neighborhood of the actual realized volatility near 30. That’s in stark contrast to the disparities seen when global stocks melted down earlier this week, the VIX soared above 30 and the strikes in its options were still things like 15, 22, 18 and 16. The gauge reached as high as 50.30 on Tuesday before falling to as low as 21.17 on Wednesday.

Jitters Sweep Across Long-Calm Junk Bond to Emerging Markets
Natasha Doff and Dani Burger – Bloomberg
As global equity markets lurch toward the worst week in years, signs have begun to emerge that the spike in volatility is seeping into other assets.

Get used to market volatility ó it’s here to stay
Merryn Somerset Webb – Financial Times
Pick up an old book on investing ó pre-1990 perhaps. Run your finger down the index. You will find no end of interesting bits and bobs under the letter “v” such as VAT, vendor placing, and mentions of a “gunslinger” fund manager called Peter de Vink.
What you won’t find is volatility. It wasn’t a thing back then. Sure, brokers referred to the odd day as being more volatile than others when they strolled into their panelled board rooms at 10-ish of a morning. But they did not trade volatility; they did not invest in it; they did not make its level the centrepiece of their investment strategy; they did not short it; and they most certainly did not refer to it as “vol”.

JPMorgan’s Kolanovic Says Some Systematic Strategies May Sell at the Lows
Joanna Ossinger – Bloomberg
Some market action playing out similarly to August 2015; Outflows likely to keep investors on edge for several days
Sell low and buy high… wait, is that the way it’s supposed to go?

As market sell-off intensifies, a search for who, or what, to blame
Bob Pisani – CNBC
One of Wall Street’s most cited observers of market volatility says the fundamentals haven’t changed, calling this a technical pullback.
A big unwinding of the “long-stocks, short-volatility” trade is seen as a reason for the spike in volatility, but others point to electronic market makers and traders following certain strategies.
Whether the market drop is because of humans or computers, everyone is looking for signs the de-leveraging is over.

A Historical Tie Breaks but Trouble Still Lurks
James Mackintosh – WSJ
The relationship between volatility and stock prices broke down spectacularly this week, and it is being taken as good news for investors.

Exchanges and Clearing

Cboe Global Markets Reports 2017 Fourth Quarter and Full Year Results
Fourth Quarter and Full – Year Diluted EPS of $2.26 and $3.69, Respectively, Which Includes a One – Time Benefit of $191.5 Million or $1.70 Per Share and $1.78 Per Share, Respectively, From Enactment of Tax Reform
Fourth Quarter and Full – Year Adjusted Combined Diluted EPS of $0.871 and $3.571, Respectively
Net Revenue of $265.6 Million for the Quarter, up 86 Percent, Reflects the Bats Acquisition
Net Revenue up 7 Percent for Fourth Quarter and Full – Year Compared to Adjusted Combined Net Revenue for Prior – Year Periods1
Organic Net Revenue up 8 Percent for the Quarter and 9 Percent for the Year1,2
Record – setting Year for Trading in VIX Futures, VIX Options, and SPX Options Volume
Bats Integration on Track; Realized Cost Synergies of Approximately $25 Million in 2017
Debt Reduction of $75 Million in 4Q17; $400 Million for the Year

***SD: Reuters – Exchange operator Cboe’s profit misses estimates as costs rise

Indian Exchanges Not To Share Market Data With Foreign Peers
Sajeet Manghat – BloombergQuint
India’s three stock exchanges will stop sharing data with foreign peers to prevent volumes from moving overseas, they said in a joint statement. The decision will halt derivatives tied to Nifty 50 Index and S&P BSE Sensex and stocks on Singapore and Dubai stock exchanges.

ICE to launch new robusta coffee calendar spread options
Agra Net
In response to customer demand, the ICE exchange will launch a new Robusta Coffee Calendar Spread Options (CSO) contract on February 15, it said.

MIAX Options Wins Best Infrastructure/Technology Initiative at Fund Technology and WSL Awards for Third Time
Press Release
MIAX Options Exchange announced today that it won “Best Infrastructure/Technology Initiative by Exchange/ATS” at the Fund Technology and WSL Awards 2018. The Fund Technology and WSL Awards 2018 recognize and honor providers catering to asset managers and institutional traders that have demonstrated exceptional customer service and innovative product development over the past 12 months. This is the third time in four years that MIAX Options has been honored as the best in this category, having previously won in 2015 and 2016. MIAX Options was also named “Best Overall Exchange” at the Fund Technology and WSL Awards 2017.


CME’s Melamed, Sandner exit board
Lynne Marek – Crain’s Chicago Business
CME Group will part with big-time institutional knowledge this year when directors Leo Melamed and Jack Sandner exit the board after a combined 90 years as members.

CME Group Inc. Names Slate of Director Nominees
CME Group Inc. today announced its slate of candidates for its board of directors for election at the company’s annual meeting to be held Wednesday, May 9, 2018.

Thesys CAT LLC Announces Executive Appointment of Vas Rajan as Chief Information Security Officer for Consolidated Audit Trail
PR Newswire

Regulation & Enforcement

Should The Feds NIX The VIX Funds, And Other Questions That Need To Be Answered
Simon Constable – Forbes
Some people may have some ‘splaining to do.
The matter at hand concerns two exchange-traded securities that were designed to profit from falls in the VIX, or volatility index, which roughly tracks the volatility of the S&P 500.
On Monday, the two funds in question, ProShares Short VIX Short-Term Futures exchange-traded fund (SVXY) and the VelocityShares Daily Inverse VIX Short-Term exchange-traded note (XIV), saw massive one-day losses resulting in the latter fund getting shuttered. Both funds profit when the price of VIX futures fall, and vice versa.


TD Ameritrade to Allow Trading via Twitter; Discount brokerage aims to woo younger, digitally savvy investors
Lisa Beilfuss – WSJ
TD Ameritrade is letting customers initialize trades over Twitter, the latest attempt by the discount brokerage to attract digitally savvy and younger investors.

Hanweck Named Best Fintech Solution
Hanweck announced that it was recognized as “Best Fintech Solution” at the Fund Technology/Wall Street Letter Awards 2018. This is the second consecutive year that Hanweck has been honored at this event, having been named “Best Risk Management Solution – Innovation” in last year’s competition.


Seismic VIX Spike May Be Behind Us But Look Out for Aftershocks
Tanvir Sandhu – Bloomberg
Stay alert to more equity fluctuations as markets normalize Cautious fast-money vol selling coming back after VIX blowout 0:13 Stocks Head for Worst Week in Almost Seven Years Stocks Head for Worst Week in Almost Seven Years The bid for volatility should ease back even while bursts of selling pressure in equities can continue.

New Era of Currency Volatility Leaves Bearish Dollar Bets Intact
Katherine Greifeld – Bloomberg
The latest turbulence in China’s yuan only adds to the complexity of a bruising stretch for global currency markets. Yet for some money managers and strategists, the path forward couldn’t be more simple: a weaker dollar.

Inverse Volatility Products Almost Worked
Matt Levine – Bloomberg
We have talked a couple of times this week about the unpleasantness experienced on Monday by investors in inverse volatility products like XIV (the VelocityShares Daily Inverse VIX Short-Term ETN, an exchange-traded note issued by Credit Suisse) and SVXY (the ProShares Short VIX Short-Term Futures ETF, an exchange-traded fund). These products were bets that volatility would go down. On Monday volatility went up. Specifically the VIX (the CBOE Volatility Index) went up by 116 percent in one day. The people who had bet that volatility would go down lost almost all of their money. That is altogether fitting and proper. When you bet that a thing will happen, and the incredibly extreme opposite of that thing happens, then you should lose your money. You can complain, but we don’t have to listen to you.

Volatility Explosion Is Sparking a Rush to Hedge at Any Cost
Cecile Vannucci – Bloomberg
Cost of protection against more S&P 500 drops reaches record; VVIX at peak; VIX 1-month versus 3-month futures at 2008 high
The days of market calm are dead. After weeks of basking in equity tranquillity and shunning protection, traders are scrambling to hedge at all costs.

Strategist Who Called VIX Blowup Says Bet on Return to Stability
Luke Kawa – Bloomberg
Macro Risk Advisors sees opportunity in VXX put spreads; Volatility-product crackup means less fuel for wild swings
Thanks to the casualties of this week’s turmoil in stocks, a certain kind of calm is poised to return.

VIX 20-20 vision needed for clear market outlook: McGeever
Jamie McGeever – Reuters
Market seismographs are still twitching at levels almost twice the historical average and Wall Street’s gauge of implied volatility needs to return below 20 percent for stocks to stabilise.
On the surface, Wall St’s 8 percent drawdown in the last week is striking but hardly earth-shattering. The market is back to where it was only 10 weeks ago, which at the time was a record high.

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