Financial Analysts Journal 20 May 2021 Volume 77 Issue 3
Volmageddon and the Failure of Short Volatility Products
“Volmageddon,” the February 2018 spike in volatility that wiped out short volatility strategies, illustrates the dangers of hedge and leverage rebalancing in highly concentrated and volatile markets.
The rapid growth of exchange-traded products (ETPs) has raised concerns about their implications for financial stability. A case in point is the abrupt market crash of short volatility strategies on 5 February 2018. In this article, we describe this “Volmageddon” event and illustrate the risks associated with hedge and leverage rebalancing when markets are highly concentrated and volatile. The Volmageddon episode provides valuable risk management lessons because it illustrates the pitfalls of hedge and leverage rebalancing and is reminiscent of the losses incurred through portfolio insurance schemes.
About the Authors
Patrick Augustin is an associate professor of finance at the Desautels Faculty of Management, McGill University, and an associate fellow at the Canadian Derivatives Institute, Montreal, Canada.
Ing-Haw Cheng is an associate professor at the Rotman School of Management, University of Toronto.
Ludovic Van den Bergen is a Student Fellow at the Marcel Desautels Institute for Integrated Management at McGill University, Montreal, Canada.