According to Alex Micalizzi, Nomura's international head of equity structured notes, the demand for structured notes has been booming, with SEC-registered US notes on track to reach $300 billion this year. However, the demand that had been driving up option premiums has disappeared, leaving banks with more volatility to offload than the market wants to absorb.
Micalizzi attributes this to large buyers who had been elevating option premiums disappearing from the market. The bank then hedges out the directional risk and is left long volatility, which it sells into the listed and broker markets. Micalizzi notes that dealers are facing a "hedging squeeze" as they try to offload volatility, but market makers are becoming more reluctant to take it.
This is creating a problem for banks, particularly with notes that have already been sold, as they may be exposed to longer-term volatility if the market moves against them. The situation is complex, and Micalizzi describes it as "peak vega," where dealers can be left short on volatility if the market rallies or falls.