ISIS Attacks Short Volatility Positions

Low volatility has been the talking point of the markets over the past couple of months as volatility compression has destroyed bank trading revenues, cut macro hedge funds off at the knees and given every bear a reason to trot out charts of how historically low vol leads to higher vol and how that implies price dumps. Which sort of fits, like a badly planned Scalextric track levered together at the last joint, but like trading RSI's as a technical signal, the underlying can keep moving a LONG way against you with only micro moves in the assumed correlation.

This year has seen many a potential macro event pop up with the potential to shake markets down to their roots but like many a Hurricane season of recent years, dire warnings of impending doom have seen each event fizzle out with only moderate breezes rippling the fronds of the market palms.

But here we go again. This time it's the Islamic State in Iraq and Syria (ISIS) attacking the short volatility positions major swathes of Iraq and threatening markets future progress towards Baghdad.  One wonders, having already asked where they get all their weapons from, if these sorts of groups partly fund themselves by front running market moves they know they will create. Manipulation - Go on Mr. Regulator, request a copy of all their communications.

I can hardly add any analysis of forecasting the likely outcome of all this as my own knowledge is only being fed by the same sources as everyone else, but I am more interested in how this will effect market psychology.

We have those that have been desperately fighting the low vol grind and have been short probably taking no action but increasing communictaions whipping up the disaster scenario. We have those that have been squeezed out of shorts reluctantly and are now probably jumping back short not wanting to miss the biggy, we have the twitchy longs who are probably getting flatter, we have the lazy longs who are hoping that this will pan out like all the other shock events of the year (namely only to mean revert 2 weeks later).

The one overriding feeling I have is that this shock has a couple of key elements to it that are more likely to give it legs than others.

- It has come from left field. Not many were expecting a drive south into Iraq from a hither little known group called ISIS. Unexpected is a huge prerequisite for shock effect.

- It ties together all the greatest of Western fears - Islamic extremism, Oil, potential need to throw your own young men into a foreign war and finally a 'whats the point' admission of impotence that you've done all this before and it was to no avail.

On those features this is a psychological biggy. But the psychology doesn't mean that the outcome will be any worse than it would without it. Just as the dread factor of sitting exams rarely has an outcome on the result.

So where do I sit in all this? Scratching my head wondering if this is the biggy, but I have been so preprogrammed by 'that wasn't meant to happen' events in markets over the past 12 months that the first thought is to sit this down move out but buy the dip when news panic is at max volume.

Time to wheel out the armchair generals. David Petraeus must be rubbing his hands together thinking of upcoming consultation and speaking fees.