What Could Lead To A “Volatility Explosion”: JPM’s Kolanovic Explains

Less than a month after the latest forecast from JPM’s Marko Kolanovic left something to be desired, when the famous quant said “it is no longer prudent to buy the dip” only for the dip to be furiously bought, whether by algos or ETFs, “Gandalf” is back with another discussion of his favorite topic, and an emphasis on a issue that is near to all traders’ hearts, namely what could lead to a “volatility explosion.”
Asking rhetorically “what will happen to Market Volatility“, Kolanovic first observes what everyone knows, namely that “volatility is near all-time lows” and adds that “the main drivers of low volatility are the currently low level of correlations, supply of options through risk premia products, and impact of option (gamma) hedging that is suppressing realized volatility (see here). Following the March option expiry and ahead of French elections, positioning reversed leading to a short-lived increase of volatility. This has now fizzled out in the aftermath of the 1st round of elections. Selling of volatility is one of the key parts of risk premia/smart beta programs. Our estimate is that ~20% of risk premia strategies are allocated to selling volatility.”
He goes on to note that selling of volatility is one of the key parts of risk premia/smart beta programs. One of the main reasons for the now daily EOD VIX slam is that a whopping ~20% of risk premia strategies are allocated to selling volatility across asset classes (and about half of volatility selling is via Equity options).

This post was published at Zero Hedge on May 4, 2017.