Thread by @jam_croissant

1/x I think most people look at IVol as a simple mean reverting fxn...They think when IVol is low it’s smart to own it & be hedged & when it’s high it’s smart to sell it...& although there is undeniably a mean reverting process at work, what most don’t understand is that for the

2/x most part over the longterm(since 1990), if you follow this process, you will get into big trouble... Other than a handful of high vol spikes w/ forced buying, when vols are low (think smoothed VIX of <17) it‘s historically, in risk adjusted terms, the most profitable to sell

3/x In effect, the risk adjusted returns of selling vol look like a big “U”, with a handful of highly profitable stressed extreme vol circumstances, paired w/the overwhelming majority of low vol occurrences representing the profitable tales, and the middle range (think VIX 17-30)

4/x representing the less profitable/more risky outcomes. What this effectively means is that for overwhelming majority of the data (with the handful of extreme vol circumstances removed)the relationship between IVol & Risk Premia is inverted. This is counterintuitive to most.

5/x So, now for the obvious question...Why is this?Most studies I’ve read center around the low intrinsic market risk factors in low vol periods & a floor to implied vol in low regimes.& though both these factors clearly have merit, i‘d argue the low risk factors themselves are

6/x themselves examples of low risk premia. My experience tells me, as we saw in 2017 (& I explain in my recent pinned tweet), it is more a fxn of the reflexivity of vol.When IVol is low, markets are inherently stable,& it takes time & sustained RVol to turn liquidity dynamics &

7/x loosen up the market, so it can experience more dramatic shocks. We saw this loosening up of vol on the back of time & sustained rVol which ultimately opened the door for 2020, just as we saw the moves in 2007 open the door for 2008-9 to occur.

8/8 So, if you are new to the game, be aware, a 25 VIX may seem rich historically & be tempting to sell. But history tells us it is ironically, one of the most profitable times to play from the long side.