Source: Wall Street See

The "short volatility" trading strategy, once seen as a "guaranteed profit" deal, suffered huge losses in the recent market sell-off.

The once popular "covered call options" ETF, has seen bloodshed. JPMorgan's Equity Premium Income Fund (JEPI) had a ROI of 4.9% from the beginning of the year until now, a 43% drop from its peak in August. Meanwhile, the ROI of Morningstar's total was 9.9%, a 40% drop from its peak.$S&P 500 Index (.SPX.US)$ The "covered call options" strategy involves buying a basket of stocks and selling yield derivatives related to the underlying assets. In recent years, the popularity of the "covered call options" ETF skyrocketed. According to Morningstar data, assets under management grew from around $18 billion in early 2022 to about $80 billion in July.

However, as the panic of a US economic recession intensified and the Bank of Japan abruptly raised interest rates, a severe stampede occurred in the market, with market volatility skyrocketing. On Monday, the CBOE Volatility Index (known as the "fear index" on Wall Street, VIX) surpassed 65, with an intraday increase of nearly 200%, marking the largest one-day fluctuation in the index's more than 30-year history. Meanwhile, as a benchmark for the "covered call options" strategy, the CBOE S&P 500 Buywrite Index fell by 2.8% on Monday, slightly better than the 3% fall in the S&P 500 index. Although the S&P 500 still rose 9% from the beginning of the year, the ROI of Buywrite was less than 4%.

As the panic of a US economic recession intensified and the Bank of Japan abruptly raised interest rates, a severe stampede occurred in the market, with market volatility skyrocketing.

On Monday, the CBOE Volatility Index (known as the "fear index" on Wall Street, VIX) surpassed 65, with an intraday increase of nearly 200%, marking the largest one-day fluctuation in the index's more than 30-year history.

Meanwhile, as a benchmark for the "covered call options" strategy, the CBOE S&P 500 Buywrite Index fell by 2.8% on Monday, slightly better than the 3% fall in the S&P 500 index. Although the S&P 500 still rose 9% from the beginning of the year, the ROI of Buywrite was less than 4%.

If you invested $100 in Global X's $8 billion Nasdaq 100 "covered call options" ETF at the beginning of 2024, it would be worth $101.45 by Wednesday's close, while investing in the underlying index would yield $106.68. Since the beginning of the year, Global X Fund's ROI has dropped more than 80%, while the underlying index has dropped 57% compared to its peak.

Although these "covered call options" funds perform well when the market is stable or rising, the additional income generated by selling options cannot offset the decline in underlying stocks during a rapid market downturn, leading to poor fund performance.

In addition, as the CBOE Volatility Index soared, some funds that sold short the index suffered huge losses, including ProShares' (SVXY.US) short-term futures ETF, which has seen almost all of its gains since the end of 2023 wiped out overnight. $ProShares Short VIX Short-Term Futures ETF (SVXY.US)$ All the gains accumulated by ProShares' (SVXY.US) short-term futures ETF since the end of 2023 have been almost completely wiped out overnight.

Once the stock market crashes, the "short volatility" strategy may become completely ineffective.

"These funds don't like volatility," said Ronald Lagnado, research director of hedge fund Universa Investments specializing in hedging severe market declines, "they call it an income strategy, but it's really just shorting volatility. This can be effective for a long time, but it may completely collapse in a market crash."

The defensive power of "covered call options" gained attention in 2022, when stocks and bonds entered a slow and steady downturn, but Lagnado said that in the long run, their performance is not much different from the classic 60/40 stock and bond combination.

Charlie McElligott, an analyst at Nomura Securities, has long been concerned about the "short volatility" trading as well as the strategies adopted by other systematic traders and quant funds. He has warned that the violent closing of these positions could trigger a "volatility event" and cause the VIX to soar to crisis levels.

Finally, this prophecy was fulfilled on Monday.

Market analysts pointed out that the "short volatility" trade was not the only strategy affected by the shock. Yen arbitrage and long bets on tech giants have also been hit hard in the recent market turmoil.

As the market collapsed, the demand indicator for hedging reached a historic panic level. Compared with call options, put options are more popular, and this preference shift has led to a sharp rise in the Put skew indicator, which measures the difference in demand for put and call options.

At the same time, the VVIX index has also risen, reflecting the increasing interest and demand of investors in options related to the VIX index and futures contracts based on it.

For example, the Put skew index measures the market's bias towards implied volatility of options, and the VVIX index measures VIX volatility.

Along with the rebound of US stocks, traders are reinvesting in the short army.

Despite some traders licking their wounds, McElligott said that as US stocks rebound, there are still some traders reinvesting in actions to short volatility.

According to data provided by him, after the VIX soared, trading to short volatility has historically brought attractive returns. Median data shows that after a year, the VIX fell by more than 60%.

According to Dow Jones market data, the VIX has fallen by more than 41% in the past two days to 22.83, potentially marking the largest two-day decline ever recorded.

Editor / jayden