Via JPM quant Marko Kolanovic:
In last week’s note, we noted that volatility, at the time, was not sufficient to trigger systematic strategy de-risking. On Friday, the market dropped ~2% on a day when bonds were down ~40bps. The move on Friday was helped by market makers’ hedging of option positions (as gamma positions turned from long to short midday). Friday’s move, on its own, was significant as it pushed realized volatility higher, which is a signal for many volatility targeting strategies to de-risk. Anecdotally, broad knowledge about the risk of systematic selling kept many investors fearful and waiting on the sidelines (both in equity and volatility markets). Midday today, short-term momentum turned negative (1M S&P 500 price return), resulting in selling from trend-following strategies. Further outflows resulted from index option gamma hedging, covering of short volatility trades, and volatility targeting strategies. These technical flows, in the absence of fundamental buyers, resulted in a flash crash at ~3:10pm today. At one point, the Dow was down more than 6%, and later partially recovered. After-hours, the VIX reached 38 and futures more than doubled—it is not clear at this point how this will reflect on various short volatility products (e.g., some volatility ETPs traded down over 50% after hours).
Today’s large increase of market volatility will clearly contribute to further outflows from systematic strategies in the days ahead (volatility targeting, risk parity, CTAs, short volatility). The total amount of these outflows may add to ~$100bn, as things stand. However, we want to point out the massive divergence between strong market fundamentals and equity price action over the past few days. The large market decline over the past few days will likely draw fundamental investors and even trigger pension fund rebalances (those that rebalance on weight thresholds). We also want to highlight a strong probability of policy makers stepping in to calm the market.
