Please Bare with me as I try to get a grip on volatility targeting and the Impact low/ high vol has on these types of positions and trades.This i hope will be a building block for me to understand the long-gamma short gamma positions that appear to dominate flows and cause most of the Movement in the SPX.
Two definitions of Volatility targeting one by CFA blog”Volatility targeting involves leveraging exposure during low-volatility periods and scaling back exposure during high-volatility periods, which will change the portfolio’s risk and return characteristics. “
Below Chart is a graph of a 10% volatility target index,which is rallying sharply as Volatility as we know has been dropping.From what I can deduce is that as the funds target 10% volatility and volatility drops then more leverage is applied to meet target of 10% and thus the rally in this index. As we can see this metric is at highest level since late 2018, i have marked the peak of this move on 10-11-18. recall before last week SPX went months without a 1% down day a perfect scenario for Volatility to trend lower.
Now lets look at SPX chart and see what it show us, I marked the 10-11-18 date on the chart as you can easily tell and what does it tell us? that SPX dropped and did not return to these levels until Q1 2019 .So as the low vol regime caused vol targeting funds to increase leverage t, similar to the path of the Vol targeting fund t hey got over extended and unprepared for Vol to spike,Once happened risky assets were sold.Now I am think out loud here and just trying to get a better understanding of how all this works so don’t take it as Gospel.So look back at Vol targeting chart above and see that leverage is Increasing towards levels not seen since late 2018 as Low Volatility rules the day,but Once a trigger is found , Corona Virus, funds will be forced to liquidate. Something I will be Monitoring to see if My hypothesis is true. I am trying to get a better understanding of Dealers gamma positions as More then one Expert preaches that as Dealers Long gamma the result is slow and steady climb in SPX dealers get short gamma then selling begets more selling.Finding the trigger level of gamma positions is the key,obviously