What Happens When You Run Out Of VIX To Short?

You just short some more…

Since December 2013, there have been more shares short than shares outstanding in VXX – the VIX ETF.

Currently, there are 2.5 times more shares short than shares outstanding… as oustanding collapses to six-month lows as shorts surge to a new record high…

and the Inverse VIX ETF – XIV – is at extremes also…

Basically this is how the Fed (explicitly or via its agents) can sell VIX in perpetuity. With almost 3x more short interest than shares outstanding (and yes we understand there is all that ETN creation malarkey), this is a blunt hammer approach…and as naked as it gets

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As JPMorgan additionally notes,

What is also evident from Figure 4 is that the recent rise of the ratio of the open interest of VIX put options over the open interest of VIX call options has risen by a lot less in the recent correction vs. that of August 2011. At the time that ratio had tripled to 1.2x vs. 0.5x currently. One anecdotal explanation for this discrepancy is that the vol of vol (VVIX) has spiked by so much in the most recent correction, that it reduced on the margin the incentive by institutional investors to buy VIX puts.

However the vol of vol had spiked to a similar level in August 2011 i.e. at 130%. A simpler explanation is that the VIX spiked at a higher level at the time, at 48 vs. 27 in the recent correction, inducing more participants to play a retracement in vol at the time. Also in August 2011, the VIX had stayed at very elevated levels for much longer, effectively until November that year.

But different to institutional investors trading VIX options, retail investors sold VIX ETFs and flocked into inverse VIX ETFs in recent weeks in similar amounts than those seen in August 2011. This is shown in Figure 5 where the 4-week flow into VIX ETFs minus the flow into Inverse VIX ETFs declined to -$1.8bn matching the low seen previously in August 2011.

Admittedly, this VIX ETF net flow slowed this week to -$42m vs. an average of -$580m in the previous three weeks. This reversal is mostly due to retail investors stopping buying inverse VIX ETFs this week following heavy buying in previous three weeks. In fact retail investors took some profit by selling a small amount of inverse VIX ETFs this week.