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mcm-ct.com @mcm_ct
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1/

VOL CONTROL/VOL TARGETING

What that got to do with the markets right now?

Well, inverted $VIX has been lagging the #equity index’s and that is a big deal. The reason it is a big deal is because the of VOL TARGETING
2/

Volatility targeting/control strategies aim to control risk by BUYING $VIX as $SPX drops and liquidating $SPX as $VIX rises.

When $SPX makes new lows but $VIX does not the implication is these insurance products continue to buy #ES_F futures while sell $VIX
3/

So what so we have here? We have an entire sector that has built a model where a divergent $VIX = increased $SPX buying via #ES_F futures.

This strategy is roughly $1 tillion in notional and like $SKEW is showing, hopelessly underhedged vs a downside break
4/

Why is this relevant now? Its because Volatility Targeting strategies are more long than they have been in a long time, based on model ideals. So, in an illiquid market, tactical/strategic exposure is likely to reassess those BUYS as soon as inverted $VIX confirms $SPX
5/

If only a small percentage of $1 trillion of #ES_F notional were to be liquidated in this illiquid environment at same time as long $VIX exposure was to be increased - we end up in Kuroda’s/@RayDalio’s virtuous cycle where MORE $VIX BUYING = LOWER #ES_F/more #ES_F Selling
6/

Market structure is completely broken - this is why @CMEGroup is willing to violate the sanctity of the futures markets price discovery to attempt to hold off the inevitable. Insurance companies/Vol Targeting strategies will dump #ES_F as soon as $VIX rises no matter what
8/

there is no alternative, this means while $VIX action was positive last week on a technical basis Vol control strategies are BUYING #ES_F since $VIX is not at new highs w at #ES_F lows & in an environment where theres not enough liquidity to dump positions at decent prices
8/

What’s the net effect of all this? Well, at worst possible time insurance firms are exposed to tail risks they were 100% seeking to avoid & in the largest exposures in recent history in the most illiquid episode in recent history. Sets up conditions for tails in #equities
9/

Absolutely believe that any progress via the $VIX index this week will unleash an iterating cycle of increasing $VIX begets Vol Targeted #ES_F selling which begets increasing $VIX which begets Vol Targeted #ES_F selling which begets $VIX buying till credit is exhausted
10/ wish all the luck in the world to traders this week BUT what we see is epic complacency were a divergence in $VIX and $SKEW is anything but bullish - its representative of all the influences that will cause outsized downside extensions and damage to the markets
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