A spike in equity implied volatility Wednesday triggered widespread talk of losses at hedge funds, which have been stepping up vol-selling strategies in the last few months. The Chicago Board Options Exchange's VIX volatility index climbed over 2.5% Wednesday to close at 16.26%, after hovering around 13% for most of the year. In Europe German volatility index VDAX-NEW also closed up at 22.06% Thursday, a 2.08% increase on Wednesday. Both indices broke 52-week highs.
Although equity derivative buy and sellsiders said it was too early to gauge the scale of gains or losses, several said the unexpected vol rise will have hit certain hedge funds hard. One strategist noted the last few months has seen an increase in hedge funds selling variance, either through Standard & Poor's 500 or Euro STOXX 50 variance option straddles (DW, 5/5). "Someone, somewhere has lost money on this," said a hedge fund salesman. The Street is abuzz with chatter of sizeable losses, particularly at European funds. But he noted, "We're not talking Long Term Capital Management here." Another salesman said losses so far will have been cushioned by gains at most funds this year.
Fund-linked desks, which provide leverage and write capital protection on hedge funds, in particular were watching out for hedge fund losses, although structurers noted the extent of the damage would not be known until May's NAVs come through. Strategists and traders were also reluctant to call whether the uptick was a temporary blip or the start of a longer-term move. One broker said, "It's hard to say. At this point it's really 'The trend is your friend.'"