“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.