That Was Just The Start: Risk Parity, CTAs Are In Process Of Selling $200 Billion
Now that inverse VIX ETFs have effectively blown up, suffering "termination events" like XIV earlier today, one of the forming bullish market narratives is that there will be no incremental "squeezed" buying of VIX from this key vol-selling group. Of course, there is a perfectly obvious flipside to that which few have pointed out, namely that holders of the inverse ETPs lost $3.4bn as the products went bankrupt, which removes a steady source of volatility supply over the last year.
But a bigger question is whether the vol selling is indeed over, and according to a just released analysts from Bank of America the answer is a resounding no. In a note from BofA's Benjamin Bowler, the derivatives expert writes that the ETP driven vol explosion which we described in painful detail previously, is just the beginning.
While BofA's model implements position changes in response to a given day's moves on the close the same day, in reality, both risk parity and CTA strategies operate over varying horizons. In any case, the bank's derivatives team expects actual rules-based risk parity and CTA strategies to implement significant allocation changes within a few days.
So, with BofA assuming $200bn in rules-based risk parity strategies and $250bn in model-driven CTAs, then its models estimate $140bn of global equity unwinds as a result of Friday's moves and another $60bn as a result of Monday's moves.
There are two ways to read that number: over the same two days global equity index futures volumes across the largest markets was approximately $1.6 trillion. So if BofA were to assume the entirety of equity unwinds were completed, then it would equate to approximately 12% of the volume over the last two days.
However, it is certain that the move is nowhere near done and BofA expects that if risk parity and CTAs are still unwinding equities in the coming days, then it will be against a continued rise in volumes due to higher volatility.
As a reminder, earlier in the day we presented calculations from Morgan Stanley's quant team, according to whom annuity funds will now need to sell between $30 and $35 bn of equities on Tuesday, and a similar amount Wednesday while Risk Parity could provide an additional $10 to $20bn in equity and bond supply this week.