(ZH) RBC: "VXX Short Utilization Spiked To An Insane 95% Yesterday"

RBC: "VXX Short Utilization Spiked To An Insane 95% Yesterday"

In his latest daily note, which does a fantastic job of exploring what the macro "big picture" looks like at this moment (more on that below), RBC's head of cross-asset strat Charlie McElligott focuses on one of his favorite topics: random outlier moves in asset volatility and, specifically, the crowding of traders behind them. And with the VIX sliding below 10 yesterday for the first time since February 2007...
... and likely set to repeat that achievement today ahead of AAPL's earnings, the RBC analyst does report some notable developments across the vol space, namely that once again everyone is piling into short inverse VIX ETFs, everyone perhaps also including pension funds.
Of particular note, McElligott writes (see below fore details) that:


"short vol' isn't just an institutional trade anymore, it's massive with retail as evidenced by the shares outstanding in the various VIX ETNs. FT highlighted over the weekend that ‘short interest’ in VXX has actually outpaced creation of new shares in VXX this years, which is indicative of this growing retail demand for the ‘strategy.’ Currently per my stock loan team, VXX short utilization spiked to an insane 95% yesterday (% of the ‘free shares’ being used to short)."

From the latest Big Picture by RBC's Charlie McElligott


SPX VOL CRUSH CONTINUES: Yesterday we hit a ‘9’ handle in spot VIX, the lowest level in implied vol since ‘08. The reasons are many.

1) The slow-and-grinding’ drag higher’ via options-market mechanics is a contributing factor. 2400 as a 'gravitational pull' in S&P index is a real phenomenon (both from 'short gamma' and 'deltas' perspective), especially with $42.5B of notional calls in weeklies across SPX, SPY and futures out through May expiration per our Andrew Ramsey.

2) Clearly ‘earnings growth’ an ENORMOUS input right now. The general equities-narrative has turned from one purely driven by the ‘direction of rates’ or ‘inflation-expectations’ experienced over the past 2 years into one where investors are focusing on analysts raising full-year EPS forecasts over the course of Q1, which is, by recent standards, unheard of.

The SPX long-term model in Quant-Insight now shows ‘1y forward earnings’ effectively as the largest ‘positive’ macro factor sensitivity to SPX price:

3) Sadly, I also think the VIX move continues to evidence the enormous crowding of 'short vol' strategies and trades in the market. 'short vol' isn't just an institutional trade anymore, it's massive with retail as evidenced by the shares outstanding in the various VIX ETNs. FT highlighted over the weekend that ‘short interest’ in VXX has actually outpaced creation of new shares in VXX this years, which is indicative of this growing retail demand for the ‘strategy.’ Currently per my stock loan team, VXX short utilization spiked to an insane 95% yesterday (% of the ‘free shares’ being used to short).

An expression of this same ‘short vol’ trade is evidenced by the growth in ‘vol writing’ funds’ AUM. DB did some work here in a recent report and discovered upwards of $45B of AUM amongst this growing universe, up from $10B pre-crisis. And you might recall me highlighting the AWESOMENESS of various pension funds crowding into ‘put-write’ overlays last Summer (see link below) on top of the consistent popularity of ‘call-write’ funds too, so this fits the story. Consultants have an easy job selling the ‘earn premium plus mute your volatility’ pitch, even if that’s not how it actually ‘works out’ in real life. This article last Fall from Pensions & Investments (“Funds Go Exotic with Put-Write Options to Stem Volatility”) is probably a good place to start driving yourself crazy http://bit.ly/2pPRAAz:



“Mr. Tirado said put-write options are becoming popular with pension funds at a time when their overall equity portfolio can be too risky and their bond portfolio isn't providing enough income in a continuing low-rate environment.

“Pension funds are between a rock and a hard place,” Mr. Tirado said. “Low funding, risky assets, both have exposure to downside risk. In this, they've constructed a strategy to transfer risk.”

Russell"s Mr. Hellekson said the strategy gives investors “a way to get defensive equity, to reach for carry when the markets are going sideways. That's attractive for some folks.” The carry comes from
the cash premium from the put option when sold. “If markets go sideways, they still get income; they can't lose,” he said.”

And of course a discussion on ‘short vol’ can’t be had without discussing the scale of ‘negative convexity’ strategies in the market place—thus my consistent focus on ‘risk parity’ funds as an example of this universe.

As per the post GFC-period where the intent of quantitative easing has been to artificially suppress financial asset volatility through ZIRP, NIRP and LSAP’s, the negative correlation of stocks and bonds has allowed for outsized returns in strategies which tactically allocate ‘risk’ based upon backward-looking volatility measures across assets, but all tied largely back into the ‘pinning’ of rates (yes, the construct changes as rates are again being allowed to move increasingly via market forces….but that’s an email for a different day!). In the meantime, we are looking at a universe where between risk-parity, risk-control and vol-target funds, we’re likely talking upwards of $1.0 to $1.5 TRILLION of AUM…and that’S without including the opaque structured-product universe.

Everybody is profiting from the trade so its popularity continues to grow, until it inevitably ‘blows up’ on something. The ‘sad’ thing is that it likely won’t even require a ‘left tail’ event with such asymmetry in the trade right now.
Aside from vol, McElligott algo looks at the Macro Story, in "one big picture", which as we have shown over the past year, is all about China:


THE MACRO STORY IN ONE ‘BIG PICTURE’: This scenario highlighted below is also part of my current ‘macro range trade’ thesis which believes you should sell ‘reflation at this 2.35 / 2.40 level in 10Y yields (and buy it again down at 2.05), as the fading Chinese liquidity- / credit- cram-down is contributing to a rollover in global inflation off its multi-year highs (which came via the ‘energy base-effect’ bounce through last year’s Chinese credit impulse, the ‘Yellen Pivot’ and OPEC deal). This was a large part of the recent ‘reflation’ unwind and squeeze in ‘rates shorts,’ which have now capitulated to the largest net spec long in UST 10Y futures in 9 years, as US data ‘beats’ are now fading in conjunction.
  • The Chinese ‘liquidity- / credit- impulse’ contracts (key on the ‘rate-of-change’ in reduction of liquidity ‘pumping’ via ‘all-system financing’).
  • As such, Chinese ‘financial conditions’ tighten significantly for the first time in 3 years.
  • In turn, Chinese inflation—and global inflation via the supply-chain—begin turning pivoting lower.
  • From there we see proxies like ‘industrial metals’ in commodities and ‘cyclicals vs defensives’ equities-pairs fade from recent ‘reflation’ highs.
  • This ‘big picture’ backdrop is part of what drove the ‘rates shorts’ into their capitulatory squeeze over the past two months—UST 10Y net spec positioning is now the most ‘net-long’ it’s been in 9 years, as US economic data trajectory fades harshly in unison.

    Nikkei : North Korea's 'failed' missile test may have been a thinly-disguised th

    North Korea's 'failed' missile test may have been a thinly-disguised threat


    TOKYO -- North Korea again launched a ballistic missile in the morning of April 29, amid growing tensions over its weapons program and increasingly threatening rhetoric between Pyongyang and Washington.

    Since the missile exploded in mid-flight, many experts branded the test a failure.

    But it could also have been a thinly-disguised warning. Pyongyang could have been saying, "We could launch an electromagnetic pulse (EMP) attack if things get really ugly." A powerful EMP would cause catastrophic damage to electrical grids and communications networks in surrounding nations, creating chaos.

    An EMP attack is based on a phenomenon the U.S. and the Soviet Union discovered and studied during their atmospheric tests of nuclear weapons in the Cold War era.

    A nuclear explosion generates a strong EMP. To maximize the damaging effect of an EMP resulting from a nuclear explosion, the bomb must be detonated at a high altitude where the air is thin.

    The strong EMP produced by a high-altitude nuclear explosion instantly generates powerful electric currents in antennas and electric cables on the ground, which in turn lead to overcurrent and overvoltage in electric devices, causing them to break down or malfunction.

    The North Korean missile launched on April 29 exploded at an altitude of 71km, according to the South Korean military. It was within the ionosphere, the ionized layer of the Earth's atmosphere, where a nuclear blast can generate enormously destructive effects.

    Hard to predict

    The equipment and facilities of the U.S. military are protected from the impact of an EMP with protective shields and other measures. But power grids and other general infrastructure are not.

    An EMP attack could cause serious, long-term disruptions in the society in Japan, South Korea, northeastern China and Russian Far East. It could shut down power grids and computer systems. The consequences would be long-term nationwide power outages and prolonged disruptions in water and gas supplies, as well as in broadcasting and telecommunications.

    The J-Alert nationwide warning system would fail to work, and the public would be deprived of access to TV, radio and internet.

    The financial system and factory production could also grind to a halt.

    In short, a single high-altitude nuclear blast could be used to disable an entire country.

    A 1962 high-altitude nuclear test above the Pacific Ocean conducted by the U.S. created an EMP that was so powerful it caused a power outage in Hawaii.

    The consequences of a HANE would be far more disastrous today because of widespread use of sophisticated electronics and society's heavy dependence on such devices. But it is impossible to assess accurately the actual scale of damage from an EMP attack.

    The use of a weapon whose effects are unknown is considered taboo in the military world.

    North Korea's military actions are often intended as messages that only military experts can decode.

    When North Korea fired seven ballistic missiles into the Sea of Japan in 2006, for instance, the message was that if a U.S. carrier strike group came close to the country it could drop a nuclear bomb over the vessels to destroy them all.

    When Pyongyang launched four missiles in March this year, it was an implied threat to stage a saturation attack against U.S. military bases in Japan to overwhelm the missile defense system.

    When North Korea conducted a massive live-fire artillery drill on April 25, it was apparently a threat to rain shells on Seoul if the U.S. makes a surprise attack on Pyongyang.

    This time, it seems that the secluded and unpredictable regime of North Korean leader Kim Jong Un, alarmed by a U.S. carrier strike group's move into the Sea of Japan, signaled its willingness to resort to an EMP attack.

    Trump response

    The question now is how the U.S. administration of President Donald Trump will respond to this latest provocation by North Korea.

    A group of retired generals handpicked by Trump to fill top administration positions, including Defense Secretary James Mattis and National Security Adviser H.R. McMaster, have gained significant influence over the administration's security policy.

    Top military officers who know well the harsh reality of the battlefield are generally cautious about starting wars. But they also abhor backing down in the face of intimidation by an enemy.

    The U.S. military has defeated the regimes of such dictators as Saddam Hussein of Iraq and Moammar Gadhafi of Libya.

    Its pride will not allow it to give in to intimidation by the young North Korean dictator.

    In the previous administration of President Barack Obama, civilian officials had enough control over the country's security policy to rein in the military.

    But it is unclear whether civilian control will work in the same way within the Trump administration, in which former generals play a key role in the policymaking process.

    Pope's warning

    North Korean leader Kim Jong Un is behaving like a knife-brandishing fanatic who has holed up in a place threatening to attack any person who approaches him.

    If he threatens to use an EMP weapon, its potential destructive power could prod the U.S. military into drastic action.

    On April 29, Pope Francis expressed concerns about rising tensions between the U.S. and North Korea, saying the situation "has heated up too much."

    The Vatican has a powerful global information-gathering network. Since the Pope, as the head of the Holy See, has access to all this information, there is good reason to pay close attention to what he says about the dangerous and volatile situation.

    Japan should prepare for various possible developments without ignoring the possibility of the situation worsening even more.

    The Japanese government is now scrambling to work out plans to protect the nation from the possible consequences of military conflict on the Korean Peninsula, including a plan for evacuating people during a missile attack.

    Some people have criticized or derided the government's actions. But this is clearly time for all of Japan to act swiftly to prepare itself for a security emergency.

    >>> Freddie Mac reports Q1 results

    Freddie Mac reports Q1 results
    • Comprehensive income (loss) was $2.2 billion in 1Q 2017, compared to ($0.2) billion in 1Q 2016, driven by the continued solid business environment and our growing guarantee businesses.
    • Our total equity was $2.8 billion at March 31, 2017. Because our net worth was positive, we are not requesting a draw from Treasury under the Purchase Agreement for 1Q 2017. Following payment of our scheduled dividend obligation of $2.2 billion in June 2017, our cumulative senior preferred stock dividend payments will total $108.2 billion. Under the Purchase Agreement, the payment of dividends does not reduce the outstanding liquidation preference of the senior preferred stock, which remains $72.3 billion. The amount of available funding remaining under the Purchase Agreement is $140.5 billion and would be reduced by any future draws.
    • Guarantee fee income 1Q 2017 vs. 1Q 2016 - increased during 1Q 2017 due to higher average contractual guarantee fee rates and the continued growth in the size of the Core single-family book. Average contractual guarantee fee rates are generally higher on mortgage loans in our Core single-family book compared to those in our Legacy single-family book... Single-family loan origination volumes increased slightly to $385 billion in 1Q 2017 compared to $380 billion in 1Q 2016. Mortgage origination data is from Inside Mortgage Finance as of April 28, 2017.
    • Our loan purchase and guarantee activity increased in 1Q 2017 due to higher refinance and home purchase loan volume driven by lower rates in late 2016 compared to late 2015. It can take up to three months between the time a mortgage is originated and when we purchase the loan.

    >>> US Gapping down

    Gapping down
    In reaction to disappointing earnings/guidance    :
    • HLIT -19%, MEDP -13.7%, (announces stock buyback), AMD -11.2%, LL -9.1%, BLDP -6.6%, CUTR -3.7%, ERJ -3.7%, FDP -3.7%, AEIS -3.5%, APU -3.5%, SHOP -3.1%, TBI -2.9%, NYLD -2.9%, HCLP -2.8%, ZIOP -2.5%, ARII -2.5%, MO -1.6%, IDTI -1.5%, MOS -1.4%, ARR -1.3%, CHTR -1.2%, CNCE -0.8%, CACC -0.6%, PFE -0.6%
    Select EU financial related names showing weakness:
    • LYG -1.4%, BCS -1.1%, CS -0.8%, DB -0.5%, ING -0.5%
    Select metals/mining stocks trading lower:
    • BHP -1.7%, BBL -1.7%, RIO -1%, MT -1%, GG -0.7%, FCX -0.5%
    Other news:
    • CGI -22.5% (after disclosing prior financial reports should no longer be relied upon)
    • SNSS -16.7% (prices 10 mln shares of common stock, undisclosed price)
    • TMHC -4.3% (commences an underwritten public offering of 10,000,000 shares of its Class A common stock)
    • AGNC -2.8% (plans to make a public offering of 24.5 mln shares of its common stock)
    • ZIOP -2.5% (announces IND to the FDA for a Phase 1 trial iinfusing its CD33-specific CAR+ T therapy for relapsed or refractory acute myeloid leukemia is now active), NVDA -1.1% (in sympathy with AMD)
    • KR -0.9% ( lower in after hours following block trade pricing)
    • AGLE -0.9% (files $150 mln mixed securities shelf offering)
    • LYB -0.9% (attributed to block trade pricing)
    Analyst comments:
    • FPO -0.6% (downgraded to Sell from Hold at Stifel)