Hedge Funds have been selling stocks and have started covering their short positions to reduce risk in the current market condition. The equity market’s volatility index has begun to climb up, thanks to Omicron virus fears in early 2022, rising interest rates, Russia’s invasion of Ukraine, and fluctuating commodity prices.
Vix’s volatility index has almost doubled since the beginning of the year, and the trend is pointing upwards, suggesting the pain isn’t over yet.
Since the 2008 market crash, the only time Vix had gone above 50 points in the last 20 years was in March 2020 – due to Covid lockdowns. And looking into the 20-year data, usually when the volatility index spikes – a recession follows it.
With risk-exposure heightening and the stock market entering into a bearish trend, Hedge funds have been raking profits while retail investors suffered losses. Bloomberg reported that the data from Goldman Sachs suggests that the selling is at its highest rate since last year. On Tuesday, Nasdaq 100 officially closed into a ‘bearish market’ (a 20% drop from its all-time highs) following the second-worst daily selloff (-3.8%) in 18 months. Although it rose a staggering 3.59% on Wednesday, it’s still down -4% from Monday’s close.
But it’s not all happy days for Hedge funds yet. According to data from Morgan Stanley, Hedge funds that play on volatility and commodity trading advisors have sold over $200B worth of global equities since the beginning of the year. In simple terms – they have oversold (shorted) equities.
Recent disclosure from Citadel Securities, one of the biggest hedge funds, shed light on how deep hedge funds are in the shorting business. With $546M cash, Citadel Securities had $73B worth of securities in hand as of Dec 2021, totaling their asset value to $79.123B and a mind-blowing $65B (approx) worth of Securities sold (and not yet purchased in its fair value) totaling their liabilities to $74B.
The Reverse Repo chart indicates that borrowing has started reducing since February 25th, which directly correlates to the start of a market-wide selloff. Retail investors aren’t selling – Market makers and hedge funds are.
Covering Short positions
Popular securities among retail investors like GameStop (NYSE: GME) and AMC Entertainment (NYSE: AMC) are down -69.8% and -78% from their respective peaks, yet the retail crowd isn’t selling them. With the volatility index creeping up and the risk exposure to hedge funds being simply unimaginable, hedge funds have slowly started to cover their short positions.
But it’s still not enough. They are over-leveraged, and the predicted market crash is not happening at the pace they expected. The options market is currently giving them a breathing space, but it’s a long road ahead for hedge funds – with many uncertainties. If this carries on, the probability of being ‘margin called’ is very high. Looking into the data, there’s no saving them from the inevitability of being forced to cover their short positions.
And this is why the ‘Apes’ of Reddit are patiently waiting and holding their stock positions.