>>> Ford Motor beats by $0.08, reports revs in-line; guides FY17 EPS above cons

Ford Motor beats by $0.08, reports revs in-line; guides FY17 EPS above consensus (11.27)
  • Reports Q2 (Jun) earnings of $0.51 per share, $0.08 better than the Capital IQ Consensus of $0.43; revenues fell 0.5% year/year to $36.93 bln vs the $37.22 bln Capital IQ Consensus.
  • Co issues upside guidance for FY17, sees EPS of $1.65-1.85 vs. $1.51 Capital IQ Consensus Estimate.
  • Lower adjusted pre-tax profit due to higher commodity cost, mainly steel, unfavorable exchange and non-repeat of last year's gain on the sale of majority stake in OEConnection LLC
  • In the U.S.: Year-over-year average transaction prices rose nearly five times the industry average in the quarter and incentives declined as a percent of vehicle price, while the industry increased
  • Automotive profits driven by North America, with Europe and Asia Pacific also profitable; outside North America, other regions were about breakeven in total; Ford Credit pre-tax profit was $619M, up 55 percent year over year
  • Automotive operating cash flow was positive; continue to expect full-year shareholder distributions of about $2.7

>>> Coca-Cola beats by $0.02, reports revs in-line; guides FY17 EPS in-line (45

Coca-Cola beats by $0.02, reports revs in-line; guides FY17 EPS in-line (45.24)
  • Reports Q2 (Jun) earnings of $0.59 per share, excluding non-recurring items, $0.02 better than the Capital IQ Consensus of $0.57; revenues fell 15.9% year/year to $9.7 bln vs the $9.62 bln Capital IQ Consensus. Price/mix growth of 3% was driven by positive operational pricing and mix, particularly in North America and Latin America. Geographic or segment mix did not have a significant impact on price/mix. Unit case volume was even and included the following performance by category cluster: Sparkling soft drinks: 0% Juice, dairy, and plant-based beverages: 3% Water, enhanced water, and sports drinks: 1% Tea and coffee: 2%
  • Co issues in-line guidance for FY17, sees EPS flat to down 2% to $1.87-1.91 (from down 1-3%), excluding non-recurring items, vs. $1.88 Capital IQ Consensus; ~3% growth in organic revenues (non-GAAP) -- No Change; 7% to 8% growth in comparable currency neutral income before income taxes (structurally adjusted) (non-GAAP), driven by strong operating performance partially offset by the impact of an increasing interest rate environment -- No Change; Full Year 2017 Currency Impact: Comparable net revenues (non-GAAP): 1% to 2% headwind based on the current rates and including the impact of hedged positions -- No Change.
  • Third Quarter 2017 Considerations: Comparable net revenues (non-GAAP): 19% to 20% headwind from acquisitions, divestitures, and structural items; 1% to 2% currency headwind based on the current rates and including the impact of hedged positions -- New Comparable income before income taxes (non-GAAP): 9% to 10% structural headwind; 2% to 3% currency headwind based on the current rates and including the impact of hedged positions
  • New Full Year 2018 Considerations: Comparable net revenues (non-GAAP): 16% to 17% headwind from acquisitions, divestitures, and structural items -- No Change.

>>> DTE Energy beats by $0.07, beats on revs; increases FY17 EPS guidance (106.

DTE Energy beats by $0.07, beats on revs; increases FY17 EPS guidance (106.30)
  • Reports Q2 (Jun) earnings of $1.07 per share, $0.07 better than the Capital IQ Consensus of $1.00; revenues rose 26.2% year/year to $2.86 bln vs the $2.35 bln Capital IQ Consensus.
  • Co raises guidance for FY17, sees EPS of $5.26-5.57 (Prior $5.15-5.46) vs. $5.33 Capital IQ Consensus Estimate.
    • "We are confident in raising our operating earnings guidance from a midpoint of $5.31 to $5.42 per share based on our continued strong performance within our non-utility businesses

FT : Noble Group announces dramatic shrink-to-survive measures, warns of $1.8bn

Noble Group announces dramatic shrink-to-survive measures, warns of $1.8bn loss

Commodity trader Noble Group has announced a dramatic shrink-to-survive programme of asset sales and a tie-up with rival Mercuria, as the under fire commodity trader warned it will post a loss of up to $1.8bn in the second quarter.

The Singapore-listed group, founded by British-born trader Richard Elman 31 years ago, said on Wednesday that a strategic review of the business – which has been hammered for more than two years by questions about its accounting and weak commodity markets – had concluded that only drastic action can keep the company going.

The company said:

The Board believes that the commodities trading industry will continue to face both challenging conditions and realignment as established participants face a low margin trading environment against the backdrop of changing banking and regulatory landscapes and the potential for digital disruption.
The Group, therefore, is positioning itself for continuing stress in the sector, which the Board believes is likely to lead to industry consolidation.

Among the announcements, the company revealed:

* A formal sales process of its Global Oil Liquids business, for which Noble says there is a “short list of potential buyers”
* The sale of Noble Americas Gas and Power Corp to Swiss-based commodity trader Mercuria’s US arm for $248m.
* The remaining Noble business, which will focus on coal, metals, carbon steel materials, freight and LNG, is entering into “partnership” with Mercuria to help improve its access to financing and to seek “strategic alliances in Asia”.
* Head count reductions from approximately 900 currently to 400
* Focus on repaying debts, including winding up secured credit lines related to its oil operations
* Further asset disposals outside North America expected to total between $800m to $1bn
* Reserving $660m against profits booked on long-term commodity contracts (Level 3 net fair value gains)
* Warned of an adjusted net loss for the second quarter of $450m to $500m, adjusted for exceptional items
* Including exceptional items, such as the reserves on long-term supply contracts, this could reach $1.8bn in total losses

(ZH) "If The VIX Goes Bananas" This Is What It Will Look Like

"If The VIX Goes Bananas" This Is What It Will Look Like

From Chris Metli of Morgan Stanley
If the VIX Goes Bananas, this is What it Might Look Like
It’s easy to become numb to the low volatility environment and the risks it presents. While trying to pick a trough in vol has been a fool’s errand, focusing on the risks resulting from vol being so low is not. Low volatility has produced a regime where the risks are asymmetric and negatively convex, so being prepared for an unwind is critical. This is not a call that vol is about to spike, but you need a plan if it does.
This note details how a short vol unwind might develop. A violent rise in volatility could be driven by just a 3% to 4% one-day S&P 500 selloff. Right now the risk is greatest in the VIX complex, and demand for VIX futures from three main sources could result in 100,000 contracts ($100mm vega) to buy in a down 3.5% SPX move. For context VIX futures ADV over the last year is 230,000 (although has risen to as high as 700,000 in big selloffs).
It’s important to note that this only happens if there is a large 1-day move lower in equities starting when VIX is very low – a slower drawdown, or a selloff from higher starting levels of vol, would not create as much demand. The biggest S&P 500 selloff when VIX was less than 12 was 3.5% (Feb 2007), so this type of move would be on par with the worst-case historical move for a low vol environment.
Why highlight this now? Simply because as volatility goes lower, these risks rise. In April and May QDS acknowledged that the short vol base was large, but viewed the risk as manageable (‘Keep Calm and Carry On’). In June the team’s stance on volatility turned neutral. And since then volatility levels have only gone lower.
What happens if the S&P 500 were to fall 3.5% today?
1) First, the VIX could rise as much as 12 points. When volatility is low it tends to move a lot for a given change in the S&P 500. That effect is likely to be exacerbated now because a) skew is steep (and VIX rolls up the skew in a selloff) and b) many players in the VIX market are short. Taking these dynamics into account QDS estimates VIX could rise ~12 points for a 3.5% 1-day decline in SPX.
If VIX rises 12 points, 1-month VIX futures are likely up 5.5 points, a ~50% increase. The 1-day percentage change is a big deal in the VIX complex because the levered and inverse VIX ETFs and ETNs rebalance daily based on the percentage change, and some of the thresholds for forced unwinds are based on the percentage change. This is why lower vol creates higher risk.
2) In a 50% increase in VIX futures, the levered and inverse VIX ETFs and ETNs need to buy ~70,000 VIX futures to rebalance their portfolios and maintain target exposures (this estimate is net of redemptions – long vol ETPs are generally sold by their holders as vol rises, offsetting the levered rebalance). While these flows likely occur near the close, the dynamic is well known, and many traders will bring forward those flows to the middle of the day.
3) A VIX futures level in the high teens (up from 11 – 12 now) means dealers get short VIX call gamma. There has been considerable buying of VIX calls and call spreads, with much of the hedging flow in the last month focused on VIX (instead of SPX). As VIX futures rise, dealers will get more and more short delta, which needs to be hedged by buying VIX futures. In a 3.5% SPX selloff QDS estimates there could be 25,000 VIX futures to buy from dealers hedging.
4) If VIX futures approach +100% in a single day, there is a risk that the providers of inverse VIX ETPs cover the VIX futures that they sold to hedge the products. This is because there is a mismatch in the hedge if VIX futures rise more than 100% – the inverse ETPs can’t go below zero (-100%) but the loss on a short VIX futures position can be more than -100%.
There are two inverse ETPs that sell the front of the VIX futures curve – XIV (an ETN) and SVXY (an ETF). For XIV (holding ~73,000 contracts short) the prospectus indicates that it will unwind if the NAV falls more than 80% intraday, with investors receiving the end of day value. Given this is a known threshold, anything close to a +80% move in VIX futures would likely trigger buying (by the ETN provider and/or market participants) in anticipation of the unwind. Note that because XIV is an ETN, investors receive the theoretical value of the index based on its rules, not what the provider actually trades.
SVXY (holding ~37,000 contracts short) does not have a set threshold to unwind according to its prospectus. That said VIX futures currently have a margin requirement of ~45% of notional for the average of the front two contracts, and any decline in value of the inverse ETPs to those levels could trigger a rapid forced unwind. Note that SVXY is an ETF, so the NAV is based on the actual holdings of the fund at the end of the day.
5) The 2nd derivative impacts are likely large. An overnight gap higher that doesn’t give investors the opportunity to hedge is the worst case. Consider if there is an overnight gap in VIX futures of +150% (VIX futures to ~29, VIX to 35+):
  • The holders of the inverse ETPs lose the $1.4bn as the AUM of inverse ETPs goes to zero.
  • The providers (hedge counterparties / clearers) of the ETPs lose $600mm due to the mismatched hedge if VIX futures more than double.
  • Investors that sold long vol ETPs against short vol ETPs (a somewhat common carry trade) have the same unhedged gap risk in a +100% VIX futures move as the ETP providers. Assuming they are 20% of the shorts in the inverse ETPs (a guess) – they lose $250mm.
  • Dealers who can’t hedge their delta on the way up could lose $500mm on our estimates.
  • Hedge funds who are short VIX futures ($250mm vega on just the short leg per CFTC) playing the rolldown trade lose over $4bn.
  • Investors who are wrong way in VXX, SVXY, and UVXY options could lose hundreds of millions – estimating loss here is hard, but assuming 20% of the open interest is wrong way, the loss would be ~$1bn.
  • Investors who have sold vol in other forms (options, variance, etc.) would take losses and likely look to cover as well.
With a buyer for every seller someone is making this money too, and some of the above could be hedged as well. But the point is that when there are losses, ‘sell what you can’ will take over and drive further supply. While the point of max pain in volatility would likely be the first day of the spike, the knock on effects could mean equity markets take longer to recover.
6) Adding to the pain – on days after the initial shock – would be the flow from annuity and risk parity deleveraging. Both of those investors are slow by comparison to the VIX market – annuities will sell over several days, starting the day after a selloff. Risk parity funds are more discretionary, and the supply could come over a matter of weeks. But given high leverage resulting from the low vol environment, their potential supply is large and could prolong any downturn.
Investors have been crying wolf about the VIX complex for years, and have been wrong so far. And it’s important to note that the odds are still heavily stacked against the above scenario playing out and the most likely scenario is still a graceful unwind of the short vol trade:
  • If volatility is just a little bit higher, the unwind potential is much less – there needs to be a shock when volatility starts at these very low levels
  • The unwind in VIX only happens in a 1-day gap lower in stocks – a slow bleed would not create as much supply
  • History suggests a gap from low vol levels is unlikely: the biggest selloff in S&P 500 when VIX was less than 12 was -3.5%, and -2.2% when VIX was less than 11, not enough to trigger this type of unwind. That -2.2% selloff occurred on Feb 4th 1994 when the Fed raised interest rates – bond volatility remains the major risk factor.
  • Investors are still not all-in on stocks, with exposures moderate and many hiding out in defensives and Tech – raising the bar for a big selloff in stocks
  • Active manager performance this year has been strong, meaning funds are less likely to become forced sellers of positions, which helps keeps volatility tame and can limit the speed of a selloff
  • Correlation remains low due to both fundamentals and positioning, and for the index to sell off sharply it would need to rise
The point is simply that if there is an external market shock that nobody is prepared for (and this likely coincides with a selloff across asset classes), the risks of a quick unwind are higher than in the past. QDS favors staying long equities, but does not view the risk / reward on simply selling volatility as attractive anymore. Instead consider:
  • Replacing long stock with S&P 500 upside calls that look very cheap given low volatility – buy the SPX Dec 2550 call (30^) for ~1% (sub-9% implied vol)
  • Buying VIX puts instead of selling VIX futures to collect rolldown – buy the VIX Sept 10.5 put for $0.25, which offers attractive leverage if futures roll down to current spot levels of VIX with a 9 handle.
  • Hedging this potential tail event with OTM VIX calls – buy the Sept 20 calls (17^) for $0.45. VIX calls are not cheap by any measure, but they are reasonably priced given these potential risks, and for those that see a shock occurring in the next few months VIX calls are the best hedge.

>>> Europe Pre-Market indications

BofA-ML
SUBSEA - Another strong beat with revs 4% and EBITDA 35% ahead of cons (125)+5%
ORANGE BEL - 3% beat to cons revs, EBITDA 9% ahead and guidance reit'd (22).+5%
PEUGEOT - 1H 10% beat,should be enough for a squeeze in stock to start(19)+3-5%
ST MICRO - Revs 1% and EBIT 5% ahead of cons. Profit guidance 3% beat (15)+3-5%
TULLOW - Little new operationally. Headline figures inline with ests (159)..+3%
SAGE - Weak Q3 nos, expensive deal but guiding to >200bps margin u/g (718)+2-3%
KLEPIERRE - Co generating good op performance, but still lagging Unibail(36)+2%
LONZA - EBIT CHF447m v bbg est 389m and co confirms FY outlook too (219)...+2%
THALES - Solid with sales 2.9% ahead of cons & guidance remains unch (95).+1-2%
KPN - EBITDA & FCF beat plus biz starting to recover. EBITDA 2.7% ahead(3)+1-2%
GKN - Profit beat with nos 2% ahead & pension costs coming down (330.9)...+1-2%
O2D - Revs 0.9% and EBITDA 2.4% ahead with capex 2.6% below cons ests (4.5).+1%
LAFARGE - Solid and CEO starts earlier than expected. EBITDA 1% ahead (58)..+1%
ENDESA - 5% ahead at EBITDA & 9% beat at net inc. Generation nos better (19)+1%
ALD - We initiate with a BUY rating, and a PO of EUR18, 15% upside (15.8)...+1%
III - Supportive with NAV a fraction ahead of exp. We raise PO to 980p (943)+1%
SNAM - Inline with N.Income 1.7% ahead and EBITDA inline with bbg cons (4)..+1%
COMPASS - Org growth 3.9% and op margins +20bps aft 9mnths as expected(1610)+1%
BANKINTER - Solid results with NII 4% ahead of cons, with Spain +3% (8.4)...+1%
MINERS - Copper +2%, Iron Ore fut -0.75% with BHP OZ +3.6%, RIO OZ +2.6%..+0.5%
REPSOL - BBB- positive from BBB- stable on a €3.8bn drop in net debt (14).+0.5%
ATOS - Nos inline with revs 10bps ahead and EBIT 2% beat. Guide unch (127)+0.5%
PROXIMUS - Positive read across from Orange Belgium numbers in fixed (31).+0.5%
ITV - EBIT beats, Q3 NAR guidance -4% (-3-5% range). FY guide reit'd (176)+0.5%
SOC GEN - CEO ruling out a tie up with Unicredit in Il Sole Interview (49.4)u/c
FRESNILLO - Q2 prodn only was inline with 14.5Moz silver +12% YoY (1528)....u/c
ACCOR - Announced 50:50 JV with Bouygues Immobilier to accelerate growth(41)u/c
UNICREDIT - Soc Gen CEO ruling out a tie up with co in Il Sole Interview(17)u/c
SEADRILL - Announce 6 wk extension to B/S restructuring talks to Sep (3.5)..u/c
RAIFFEISEN - We UPGRADE to BUY taking our PO to EUR28 (see 18% upside) (24)-1%
DAIMLER - Q2 headline miss,cars inline but reported EBIT 3% miss v cons (60)-1%
HAMMERSON - Headlines solid with NAV +4.3% but u/l trends not so good(577)-1-2%
MICHELIN - Disappointing nos. Mgmt confident pricing sticks into 2H (114)...-2%

CSFB
ALD M/P CS INITIATE with NEUTRAL (Risks balanced)
Antofagasta M/P Production inline, Net cash costs better
Atos M/P Confrims FY targets as H1 net rises 25%
Bankinter +2% Q2 NII 3.5% ahead, net income 10% ahead
Calida M/P Sales slightly light CHF175.6m (cons 182), outlook fine
Compass +1-2% Organic growth +3.9% vs CS ests +3.1%
Cramo -1-2% Sales 178mln cons 184.8mln, EBITA 27.8mln cons 28.82mln
Daimler -1-2% 2Q revs EU41.2B est EU41.19B, EBIT EU3.75B est EU3.90B
Enel +0.5-1% Positive read from Endesa numbers
EFG Int +2-3% H1 Gross profit 5% ahead, Underlying profit 20% ahead
EI Towers +1-2% Core Revenues 1% ahead, Adjusted EBITDA 3% ahead
Endesa +1-2% Net Income of 653m v CS at 635m, EBITDA 1.61b v CS 1.594b
Fresnillo M/P On track to achieve 2017 production guidance
GEA Group -1% Orders, sales, adjusted EBITA and 2017 guidance
GKN +1-2% 1H sales GBP4.88B vs GBP5.01B, profit inline
Hammerson +1-2% Nav 771 +4% vs CS around flat
Inficon +1-2% Revs $93.6m vs cons $90.1m, EBIT inline
Inwit +1% Q2 Headline Revs + EBITDA +1% vs cons, FCF better
ITV +1-2% Maintains FY guidance
Jupiter UNCH Inflows in line, net revs 2% light, costs higher
Klepierre +1% EPRA NAV €37 is 1% better than Dec, upgraded FY cash flow
Kloeckner M/P EBITDA €63m vs cons €62m, net debt stable, outlook inline
KPN +2% Q2 Rev EU 1.63bln cons EU 1.63bln, EBITDA beat
Kion M/P Q2 revs slightly light €2.02bn vs cons €2.05bn, confirm FY
Lafarge UNCH Q2 revs 6.85b vs cons 6.92b, confirms 17 tgts
Lonza +3% Revs 2.32b vs cons 2.2b, raised guidance
Marstons +1-2% lfl taverns +1.9% and destination/premium +1.3%
Michelin -1% Revs 11.06bn cons 11.1bn, Operating income inline
Miners UNCH Copper +1.90%, Brent +1.25%, Iron Ore -1.30%, China -0.60%
Norsk Hydro +1% CS UPGRADE to OUTPERFORM (China supply side reform)
O2D +2-3% Q2 Sales EU 1.77b est EU 1.76b, confirms full year
Oils +0.5% US API data showed a draw of -10.2m barrels
Orange Bel +5% Revs 3% ahead, EBITDA 10% ahead, FY17 guidance reiterated
Peugeot +2-3% 1H Operating Profit Climbs; Upgrades Auto Market Forecasts
Rob Walters +1-2% Tax rate lower, divi better
Renault +1% Positive read from Peugeot numbers
Sage +1-2% Buys Intacct for $850M, maintains FY, CS UPGRADE to O/P
Snam +0.5% H1 EBITDA at 1,035mn vs 1,027 cons, net slightly ahead
STM +3-4% Q2 revs $1.92b est $1.91b, margin better, Maintains FY
Subsea +5% 43c v 29c expectations, EBITDA its a 40% beat
Thales +1-2% Confirms 2017 targets. H1 Sales EU 7.24b
Tullow Oil +1-2% No's inline with pre-announce back in June
Unite Group M/P No's inline, outlook on trading relatively upbeat
Valora +1-2% H1 Sales 0.5% light, EBIT margin improved, EBIT 4.5% ahead
VAT Group +3% H1 sales CHF326m vs cons 335m, solid margin guidance

MainFirst Pre Mkt Indications
*LONZA-Rev 2.32b(2.2),GM 38%(33),Ebit 373m(389),Ebitda 529m(558)....+3.5%
*ASMI-Rev 202.05m(191),GM 43.7%(44),OP 37.72m(35.8),Q3 Rev ok.......+0.5%
*LAFARGE-Op Ebitda 1.74b(1.73),Net Sales 6.85b(6.92),o/lk ok........-0.5%
*STM-OP 184m(180.4),Rev 1.92b(1.91),GM 38.3%(38.1),H2 looks ok......+3%
*THALES-Net 336m(337),Ebit margin 8.8%(8.7),FCF 216m(+ve),o/lk ok...+1%
*ATOS-Rev 6.87b(6.31),Net 211m,Op Margin 8.5%,Confirms '17 tgts.....+2%
*KLEPIERRE-H1 Rental Inc 527.1m,Lifts FY Cash flow outlook..........+0.5%
*MICHELIN-Sales 11.06b(11.2),Op Inc 1.42b(1.41),Outlook unch........-1%
*KION-Rev 2.02b(2.05),Ebit 214.2m(211.3),Outlook for '17 ok.........+1%
*M6-Rev 662.4m(653),NI 69.1m(56.1),aims to o/p ad mkt in H2.........+1%
*WORLDLINE-Rev 778m(770),NI 51m(55),Co raised FY guidance...........+1%
*SNAM-Rev 640m(634),NI 250m(244),Ebit 361m(359),Ebitda 521m(521)....+1%
*DAIMLER-Ebit 3.75b(3.9),Rev 41.2b(41.19),sees significant grth.....-1%
*PEUGEOT-H1 Rev 29.2b(28.1),OP 2.04b(1.79),upgrades auto mkt f/c....+1%
*KPN-Rev 1.63b(1.63),Ebitda 601m(576),FCF +296m,Capex 238m..........+2%
*TEF DEUTS-Sales 1.77b(1.76),Adds 518k connections,Confirms FY......+1%
*SEB-H1 Rev 2.94b(2.96),Ebit 202.7m(240),NI 83m,FY Sales Grth 7%....-3%
*ELMOS-Sales 59.5m(60.9),Ebit 6.2m(5.6),Raises FY Ebit margin.......+0.5%
*KLOECKNER-Rev 1.598b(1.6),Ebitda 63m(60.2),Net 23.43m(22.6)........+2%
*VOSSLOH-Rev 267.9m(262),Ebit 24.6m(17),Confirms FY guidance........+0.5%
*PUMA-Confirms numbers & raised outlook on the 17th July............+0.5%
*SOC GEN-Rules out a merger with Unicredit,new bizz plan in Nov.....U/C

(ZH) "If The VIX Goes Bananas" This Is What It Will Look Like

"If The VIX Goes Bananas" This Is What It Will Look Like

From Chris Metli of Morgan Stanley
If the VIX Goes Bananas, this is What it Might Look Like
It’s easy to become numb to the low volatility environment and the risks it presents. While trying to pick a trough in vol has been a fool’s errand, focusing on the risks resulting from vol being so low is not. Low volatility has produced a regime where the risks are asymmetric and negatively convex, so being prepared for an unwind is critical. This is not a call that vol is about to spike, but you need a plan if it does.
This note details how a short vol unwind might develop. A violent rise in volatility could be driven by just a 3% to 4% one-day S&P 500 selloff. Right now the risk is greatest in the VIX complex, and demand for VIX futures from three main sources could result in 100,000 contracts ($100mm vega) to buy in a down 3.5% SPX move. For context VIX futures ADV over the last year is 230,000 (although has risen to as high as 700,000 in big selloffs).
It’s important to note that this only happens if there is a large 1-day move lower in equities starting when VIX is very low – a slower drawdown, or a selloff from higher starting levels of vol, would not create as much demand. The biggest S&P 500 selloff when VIX was less than 12 was 3.5% (Feb 2007), so this type of move would be on par with the worst-case historical move for a low vol environment.
Why highlight this now? Simply because as volatility goes lower, these risks rise. In April and May QDS acknowledged that the short vol base was large, but viewed the risk as manageable (‘Keep Calm and Carry On’). In June the team’s stance on volatility turned neutral. And since then volatility levels have only gone lower.
What happens if the S&P 500 were to fall 3.5% today?
1) First, the VIX could rise as much as 12 points. When volatility is low it tends to move a lot for a given change in the S&P 500. That effect is likely to be exacerbated now because a) skew is steep (and VIX rolls up the skew in a selloff) and b) many players in the VIX market are short. Taking these dynamics into account QDS estimates VIX could rise ~12 points for a 3.5% 1-day decline in SPX.
If VIX rises 12 points, 1-month VIX futures are likely up 5.5 points, a ~50% increase. The 1-day percentage change is a big deal in the VIX complex because the levered and inverse VIX ETFs and ETNs rebalance daily based on the percentage change, and some of the thresholds for forced unwinds are based on the percentage change. This is why lower vol creates higher risk.
2) In a 50% increase in VIX futures, the levered and inverse VIX ETFs and ETNs need to buy ~70,000 VIX futures to rebalance their portfolios and maintain target exposures (this estimate is net of redemptions – long vol ETPs are generally sold by their holders as vol rises, offsetting the levered rebalance). While these flows likely occur near the close, the dynamic is well known, and many traders will bring forward those flows to the middle of the day.
3) A VIX futures level in the high teens (up from 11 – 12 now) means dealers get short VIX call gamma. There has been considerable buying of VIX calls and call spreads, with much of the hedging flow in the last month focused on VIX (instead of SPX). As VIX futures rise, dealers will get more and more short delta, which needs to be hedged by buying VIX futures. In a 3.5% SPX selloff QDS estimates there could be 25,000 VIX futures to buy from dealers hedging.
4) If VIX futures approach +100% in a single day, there is a risk that the providers of inverse VIX ETPs cover the VIX futures that they sold to hedge the products. This is because there is a mismatch in the hedge if VIX futures rise more than 100% – the inverse ETPs can’t go below zero (-100%) but the loss on a short VIX futures position can be more than -100%.
There are two inverse ETPs that sell the front of the VIX futures curve – XIV (an ETN) and SVXY (an ETF). For XIV (holding ~73,000 contracts short) the prospectus indicates that it will unwind if the NAV falls more than 80% intraday, with investors receiving the end of day value. Given this is a known threshold, anything close to a +80% move in VIX futures would likely trigger buying (by the ETN provider and/or market participants) in anticipation of the unwind. Note that because XIV is an ETN, investors receive the theoretical value of the index based on its rules, not what the provider actually trades.
SVXY (holding ~37,000 contracts short) does not have a set threshold to unwind according to its prospectus. That said VIX futures currently have a margin requirement of ~45% of notional for the average of the front two contracts, and any decline in value of the inverse ETPs to those levels could trigger a rapid forced unwind. Note that SVXY is an ETF, so the NAV is based on the actual holdings of the fund at the end of the day.
5) The 2nd derivative impacts are likely large. An overnight gap higher that doesn’t give investors the opportunity to hedge is the worst case. Consider if there is an overnight gap in VIX futures of +150% (VIX futures to ~29, VIX to 35+):
  • The holders of the inverse ETPs lose the $1.4bn as the AUM of inverse ETPs goes to zero.
  • The providers (hedge counterparties / clearers) of the ETPs lose $600mm due to the mismatched hedge if VIX futures more than double.
  • Investors that sold long vol ETPs against short vol ETPs (a somewhat common carry trade) have the same unhedged gap risk in a +100% VIX futures move as the ETP providers. Assuming they are 20% of the shorts in the inverse ETPs (a guess) – they lose $250mm.
  • Dealers who can’t hedge their delta on the way up could lose $500mm on our estimates.
  • Hedge funds who are short VIX futures ($250mm vega on just the short leg per CFTC) playing the rolldown trade lose over $4bn.
  • Investors who are wrong way in VXX, SVXY, and UVXY options could lose hundreds of millions – estimating loss here is hard, but assuming 20% of the open interest is wrong way, the loss would be ~$1bn.
  • Investors who have sold vol in other forms (options, variance, etc.) would take losses and likely look to cover as well.
With a buyer for every seller someone is making this money too, and some of the above could be hedged as well. But the point is that when there are losses, ‘sell what you can’ will take over and drive further supply. While the point of max pain in volatility would likely be the first day of the spike, the knock on effects could mean equity markets take longer to recover.
6) Adding to the pain – on days after the initial shock – would be the flow from annuity and risk parity deleveraging. Both of those investors are slow by comparison to the VIX market – annuities will sell over several days, starting the day after a selloff. Risk parity funds are more discretionary, and the supply could come over a matter of weeks. But given high leverage resulting from the low vol environment, their potential supply is large and could prolong any downturn.
Investors have been crying wolf about the VIX complex for years, and have been wrong so far. And it’s important to note that the odds are still heavily stacked against the above scenario playing out and the most likely scenario is still a graceful unwind of the short vol trade:
  • If volatility is just a little bit higher, the unwind potential is much less – there needs to be a shock when volatility starts at these very low levels
  • The unwind in VIX only happens in a 1-day gap lower in stocks – a slow bleed would not create as much supply
  • History suggests a gap from low vol levels is unlikely: the biggest selloff in S&P 500 when VIX was less than 12 was -3.5%, and -2.2% when VIX was less than 11, not enough to trigger this type of unwind. That -2.2% selloff occurred on Feb 4th 1994 when the Fed raised interest rates – bond volatility remains the major risk factor.
  • Investors are still not all-in on stocks, with exposures moderate and many hiding out in defensives and Tech – raising the bar for a big selloff in stocks
  • Active manager performance this year has been strong, meaning funds are less likely to become forced sellers of positions, which helps keeps volatility tame and can limit the speed of a selloff
  • Correlation remains low due to both fundamentals and positioning, and for the index to sell off sharply it would need to rise
The point is simply that if there is an external market shock that nobody is prepared for (and this likely coincides with a selloff across asset classes), the risks of a quick unwind are higher than in the past. QDS favors staying long equities, but does not view the risk / reward on simply selling volatility as attractive anymore. Instead consider:
  • Replacing long stock with S&P 500 upside calls that look very cheap given low volatility – buy the SPX Dec 2550 call (30^) for ~1% (sub-9% implied vol)
  • Buying VIX puts instead of selling VIX futures to collect rolldown – buy the VIX Sept 10.5 put for $0.25, which offers attractive leverage if futures roll down to current spot levels of VIX with a 9 handle.
  • Hedging this potential tail event with OTM VIX calls – buy the Sept 20 calls (17^) for $0.45. VIX calls are not cheap by any measure, but they are reasonably priced given these potential risks, and for those that see a shock occurring in the next few months VIX calls are the best hedge.