Picking Up Nickels

If you saw a nickel on the ground, would you pick it up? Would your answer change if it was a $1 bill? How about a bag of $100 bills?

Thus far in 2017, short volatility traders have been picking up the equivalent of industrial-sized garbage bags filled with $100 bills. In shorting equity volatility – via ETFs, futures, or options – they have been earning what seems like a risk-free reward. Volatility has never been this consistently low for so long and shorting it has therefore never been easier.

Lowest daily closes of volatility index from 1990 to 2017

But the word around town is finally getting out. It is hard to keep traders quiet for long when they are picking up bags filled with $100 bills.  Non-commercial futures traders have built up their largest net short volatility position in history. Everyone, it seems, is lining up to receive their free bags of money.

Image of Non-commercial positions of VIX futures

What could go wrong here? Nothing at all, I’m sure, unless by some freak occurrence there happens to be a bulldozer or steamroller passing by.

For a long time, the geniuses at Long Term Capital Management (LTCM) picked up nickels in what seemed to be a risk-free arbitrage. With annualized returns of almost 40%, those nickels added up to a nifty sum. And then, just like that, it was gone. A steamroller passed by in May 1998, and then another in June, and then a few more in July and August.

By September 25, 1998, LTCM’s equity moved down to $400 million. With liabilities of over $100 billion, they were leveraged 250 to 1. The partners of LTCM once had $1.9 billion of their own money invested in the fund, all of which was wiped out. A bailout by the Federal Reserve Bank of New York was organized to prevent a wider financial collapse.

Comparison between LTCM, DJIA and US Treasury from 1994 to 1998

It’s been almost 20 years since LTCM and nearly 10 years since the 2008 financial crisis. Memories fade and new traders without that emotional baggage have entered the markets.

How many of these traders today have leveraged short volatility positions on, operating under the assumption that volatility will stay low forever? I don’t know, but we’ll find out soon enough. The names change but the moral of the story never does. If you pick up nickels long enough you will one day look up to find a steamroller inches away.

Think you can move out of harm’s way in time? Indeed, as does everyone else.


Related Posts:

From Silver Linings to Gray Skies

Is Shorting Volatility a Free Lunch?

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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.


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