Thread by @6_Figure_Invest

Thinking about a nightmare scenario associated with $VXX's resumption of share creations in Sept/Oct. VXX been available to short since start of this fiasco in March. This is surprising since parties loaning out shares are sitting on a 30% premium that will go away #VXX #$VXX

I suspect most of these lenders are Create-To-Lend (CTL) operations. They bought VXX shares, near-perfectly hedge them with VIX futures or short $VIXY and lend out the shares to shorts for a sweet borrow fee (last I hear at the rate of 30% per year).

When VXX's premium appeared in late march the CTLs would have seen a massive paper profit materialize, VXX +30% and their short VIX futures positions unchanged. Some may have cashed out at that point, but why not collect huge borrow fees now and then sell at the last minute?

To sell their $VXX shares the CTLs have to recall the shares they have loaned out. When someone is short a stock that is recalled they have to immediately find other shares to borrow or close out their position by buying back the stock on the exchange.

This could lead to a perfect storm situation. What if right before VXX share creations resume CTLs recall & sell their VXX shares? Shorts that have their shares recalled will find 0 shares available to borrow-longs all selling positions in anticipation of premium disappearing

The shorts are forced to cover, closing out their positions by buying VXX, which still has the premium! At this point they have no VXX position, so they don't suffer the loss of the premium when creations resume, but the gain they thought they had locked in has disappeared.

The short $VXX, long $VIXY trade that looked like a sure winner yanked away at the last minute, leaving the trader down the borrow fees, any additional premium that developed after they shorted VXX, & likely down on their long $VIXY position.

Massive selling by the CTLs before the creations resume might drive down VXX's premium, but if there is forced buying by the shorts covering it might cancel out the impact on the premium.

Of course, I might be missing something critical, but if you're short $VXX waiting for the premium to disappear it seems like you need to consider the share recall possibility. Similarly, positions of DITM short VXX calls with expirations--past Sept 12 will likely be exercised!

@threadreaderapp unroll