Extremely low volatility environment - it´s one big taxpayer sponsored subsidy. Best vol buying opportunity since spring 2008?

Centralbank volatility subsidies - increasing cost, increasing risk.

I guess it's been going on for almost three and a half years now. During this period, central banks all over the world has used taxpayer money for capital destruction. Medicine will have to be taken no matter what. The question is if taxpayers should have to take even more risk first - and then get hit anyway?


Well, let me explain my thinking. If one accepts the fact that buying a bond is the equivalent of selling a put, then follows that central banks have been selling puts for the thre and a half years - generating a short options portfolio for the taxpayers, who ultimately are backing the central banks.

If one also considers that many central banks have been buying junk credits, central banks have, on top of it, created a short convexity portfolio. In a subsidized, synthetically low volatility environment, this might work ok. However, in an increasing to high volatility environment on the other hand,,,,, not so good.

This is also in addition to the biggest debt and global macro imbalance this world has ever faced.

So, where are we in all this?

Well, stars might be lining up and solar activity is on a definite increase.

Consider the following variables;

* Chinese currency reserve growth ; zilch. When it goes into reverse - watch out.
The Chinese have not acted smarter than the rest of us, nor do they have a superior market system.
Rather the opposite. Their short sighted and panicky injection of 1.8 Trn Usd into their financial system during the financial crisis made generated further waves of bubble building. China to some extent now a "short gamma" economy; caught between debt driven into negative yield investments and no growth.
If they push bank reserve requirements up; growth falls. If they reduce them, inflation shoots (due to way too low interest rates, making saving capital non attractive, pushing capital into assets instead).

The bubbles in realestate, the bankrupt regions, the bankrupt five biggest banks(measured in terms of bad debt), the massive negative yielding infrastructure investments and the corruption are areas I don´t have time to go through at this time, but they do certainly not have a positive impact.

Which brings us into the subject of the "curse of the fixed exchange rate" - but this is material for a separate article.

* The Euro area situation - say no more. It´s game over, whether they know it or not.
Witness the separatist activity within various countries in Europe; Spain, Italy, France, etc
 "Rich" areas want to break free from the financing burden. If there´s no "solidarity" domestically, how can anyone expect this between countries in Europe. It´s all a fudge and the European citizens will sooner or later dump Brussels. Why? Europe can't afford their capital destructive spending sprees.
EU budgets are to be increased. (The poorest nations with the biggest populations wants to increase it - so that´s the way it´s most likely to play out.)

* The US fiscal situation - being the world currency means it´s both a blessing and a curse.
EG; you will be receiving finance for longer, but you will also be allowed to dig a deeper hole before financing is denied. Ending up with a global "too big to bail" situation.
It also means the pressure on any nation silly enough to run a fixed exhange rate regime will be under even more pressure.

* The current regulation and its effects.
Lower market risk absorption capacity. Increased gap risks/digital risks - especially as asset volatilities increase. The changing of financial participants business models.
This factor will may also have a way greater effect than what is currently recognized amongst market participants.

The drive for certain assets due to regulatory incentives has also pushed the herd into an investment corner consisting of low risk premiums, which it might become really hard to get out of.


* The continued reliance on Markowitz / portfolio theory, utilizing linear products.
Indicates not much in the way of risk management and infrastructural shifts have been made within the industry - so far.

There are more aspects which also will have to be postponed for another post, but the above and several decision making events globally could generate the spark necessary to throw us into the next extremely volatility phase of this crisis.


* Some other macro risks
There are plenty around; EU budget, - financing, Chinese new president, Russia, Egypt, Israel - Iran, Argentina, South Africa, rising soft commodity prices -refugee flows etc, etc.


Bottom line; absolute vol is heavily subsidized in general, but many can´t take advantage of it - which makes it even more interesting for the ones who can. The key lies in the structure.

Although a very longtime since last said - good luck.










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