Crushing the VIX
A new type of trade has come into the fold- with massive consequences for financial markets. Volatility is being crushed in real time. Welcome to the Rise of Carry.
Carry trades have been around since the dawn of financial markets. These types of trades make money in the absence of volatility- that is, when “nothing happens”. Author Kevin Coldiron points out in his book “The Rise of Carry'' that many financial transactions can be construed as “carry trades”- banks borrowing depositor money and engaging in mortgage lending, hedge funds borrowing short term paper and speculating on long bonds, sovereign nation states issuing bills and buying long term assets. The effect of these trades is shorting volatility- making sure that the cost of the borrow does not rise too high or the return on the asset does not fall too low. The higher the vol, the more likely this will occur, and the higher risk that the carry trade blows up. Since the returns on an individual carry trade are usually low, investors lever themselves multiple times to squeeze out more gains on a single position. This pushes even more funds into the carry receiving assets, increasing liquidity and overall price.
We can thus summarize the key characteristics of a carry trade as follows:
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