The Yen Carry Trade

Between August 2 and August 5, 2024, the CBOE Volatility Index (VIX), commonly known as Wall Street’s “fear gauge,” experienced a historic surge, marking its largest intraday jump on record.

Several factors contributed to this unprecedented spike:

1. Global Equity Sell-off: On August 5, 2024, global markets, particularly in Japan, witnessed significant declines. The Japanese equity market fell by 12%, setting a tone of uncertainty for the U.S. pre-market session.

2. Unwinding of the Yen Carry Trade: The sharp movements in the Japanese market led to the unwinding of the yen carry trade. This strategy, where investors borrow in low-yielding currencies like the yen to invest in higher-yielding assets, became less attractive amid rising volatility, prompting a rush to exit these positions.

3. Market Makers’ Quote Adjustments: In response to the heightened uncertainty, options market makers widened bid-ask spreads, especially for less liquid put options. Since the VIX calculation relies on mid-quote prices, this widening artificially inflated the index, amplifying the perceived market volatility.

4. Pre-market Trading Dynamics: The VIX is calculated based on quotes rather than actual trades. During pre-market hours, lower liquidity and wider spreads can lead to exaggerated movements in the index. On August 5, traders rushed to cover short volatility positions before the market opened, further contributing to the VIX spike.

5. Increased Demand for Short-Dated Options: The growing popularity of short-dated options, known as 0DTE (zero days to expiration) options, may have also played a role. The surge in demand for these instruments can lead to rapid adjustments in market makers’ hedging strategies, impacting volatility measures like the VIX.

It’s important to note that while the VIX is a widely used indicator of market sentiment, its reliance on quoted prices makes it susceptible to distortions during periods of low liquidity and widened bid-ask spreads. The August 2024 spike serves as a reminder that such anomalies can occur, and investors should consider multiple factors when assessing market risk.

The spike in the VIX on August 5th, 2024