SocGen Says “Reduce Risk”: Hedge Funds Have Never Been This Short The VIX

Earlier this week, in the latest observations of broad market complacency, we pointed out that the VIX has remained heavily subdued in September – a month when volatility usually picks up – shrugging off rising geopolitical tension with North Korea, several destructive storms, and the Fed’s plan to normalize its balance sheet, while defying seasonal trends. As of Tuesday, the average VIX close in September month-to-date was just 10.60, which is the lowest average September on record. Since then, the VIX has declined even further.

Just as notable, the September 17 VIX settlement was 9.87. This was the lowest monthly settlement on record and only the second sub-10 monthly settlement (the other was in Feb 2007 when the VIX settlement was 9.95). Even more striking, monthly settlements are typically high in September as the average settlement during September since 2004 is 19.69, the fifth highest relative to other months. Putting the VIX performance in context, comparing 2017 monthly VIX settlements to historical norms, this month’s 9.87 print was the farthest below the mean.

So yeah, based on broad measure of implied volatility, which in turn also reflects realized vol, complacency abounds, which is not a surprise during a year of “global recovery” in which central banks have injected $2.2 trillion in liquidity.

It should also not be a surprise that, as SocGen writes, low volatility leads to a false sense of security. In a note by Arthur van Slooten, the SocGen strategist writes that “for a wide range of assets, current volatility levels have reached historical lows. In normal times, volatility is one of the most fundamental risk indicators that helps make a useful comparison between different asset classes.”

However, the current levels are so low “that they give falsely reassuring messages” according to SocGen. Consequently, the French bank notes that “assets with vastly different risk profiles get treated basically in the same way, caught in the relentless hunt for the last remaining sources of yield as the only focus.”  Hence, SocGen’s warning: “Beware complacency. Reduce Risk“

Going back to the top charts, SocGen brings attention to the most popular indicator of complacency: the VIX, or rather its record low, 3-sigma net short position.

A fitting example of extreme positioning is the unusually strong level of net short positions on implied equity volatility (VIX), more than three standard deviations below the long-term average. Despite very low levels (spot VIX at 9.87 on 27 September) hedge funds continue to expect this very low volatility environment to continue. If it does, the strong skew in volatility futures results in attractive returns.

For those tired of the old “collecting pennies in front of a steamroller” analogy, SocGen has another one to describe this state of affairs:

“Compare that with dancing on the rim of a volcano. If there is a sudden eruption (of volatility) you get badly burned.”

Putting this historic, 3-sigma bet on declining VIX which is already at record low levels, is the following SocGen chart: