Volatility Trade Returns Raise New Fears of Market Meltdown
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A short volatility (short vol) trade that caused a market meltdown in 2018 made a comeback in 2022, raising fears it could destabilize markets again if volatility spikes.
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Funds that sell options to generate income have seen massive growth recently, increasing short vol exposure.
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A complex options strategy called the "dispersion trade" that bets on divergence between index and single stock volatility also became very popular, possibly overcrowded.
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The short vol trade had its best year of returns since 2017, indicating significant exposure that could unwind if volatility rises.
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While unlikely to cause a meltdown like 2018 again, the crowded short vol trade still poses risks of spurring broader market unrest if volatility spikes.