Impact from short equity volatility set to fade, BofA says

A bubble might have popped on Monday, a bubble in equity volatility that is, according to analysts at Bank of America-Merrill Lynch.

However, absent contagion to interest rate volatility from one of the largest deleveragings in quantitative funds ever, "dislocations" should quickly fade, they said.

"While concerns over rates risks are the common narrative, rates vol remains remarkably subdued. Rather, the largest shocks look more driven by positioning in equities and short equity vol, which generated the largest rise in VIX futures in history - illustrating both the value in VIX "fragility hedges" and the risks to some popular short vol strategies that are now at risk of being wiped out," the analysts wrote in a research note sent to clients.

CTA and so-called risk-parity funds likely contributed to the selling, BofA added.

Nevertheless, Monday's blood-letting in markets was another "wake-up" call that equities had been significantly underpricing risk, the investment bank added.

In the same report, BofA also pointed out how the unusually high correlation year-to-date between the European Stoxx 600 benchmark and 10-year German bund yields, which was in its 2nd percentile since 2000.

Furthermore, adjusted for volatility the year-to-date move in 10-year bund yields had been the second biggest since at least 1989.