Thanks to Will Thompson. I got a nice mention here explaining how tail hedging can cause the kind of volatility we are now seeing, much like the crash of 1987:
Volatility: An Asset Class or Quick Buck?
Posted on August 8, 2011
The CBOE Volatility Index, commonly referred to as the market’s “fear index,” has had a one-day range of 27.54 to 39.25. As the past week showcases a near 30 percent change in the VIX, market participants wonder if the great volatility era has returned.
“Institutions have increased interest in volatility, not the VIX per se, but more so, hedging tail risk,” said Warren Mosler, co-founder of AVM L.P, a provider of brokerage, trading and administrative services to its affiliates, one of which is eponymous hedge fund III Associates, based in Boca Raton, Florida.
Mosler, currently a resident of the U.S. Virgin Islands, had run for the U.S. Senate in 2010, and is a published economist.
“There are programs out there to hedge tail risk when extremes happen because people want to be protected,” Mosler told Markets Media. “Out of the money options have gone way up, and they’re going to stay high for a long time. There has been a real shift of money into these strategies.”
Ironically, Mosler noted that increasingly used practices, such as tail hedging are propelling more volatility in the markets, causing a pro-cyclical self-fulfilling prophecy in the markets. Investors create fear to protect themselves from fear.
Despite an increased institutional interest in utilizing volatility, it remains to be a measure of protection, not a standalone asset class, for fund managers.
Volatility is traded more but it’s not an asset class by traditional definition, according to Mosler. “It’s a money-making activity, a way to hedge a position, a way to express one’s view.”