Let’s take a look at the condition we were in as we approached February 2018:
- Thousands of investors were unwittingly stuck in an enormously crowded short VIX trade via ETFs like XIV and SVXY, which had sucked up billions of dollars due to strong previous performance.
- The VIX was approaching all-time lows, which meant that investors could charge near-all-time lows for providing market crash insurance.
In markets, causality and effect rarely follow a straight path. Many times, seemingly inconsequential events can spark a market crisis due to a series of nonlinear and unexpected relationships.
Prior to February 2018, stock markets had been so quiet (and the VIX had been so low) that even a slight drop might send investors into a panic. And that’s exactly what happened: the VIX (and VIX futures contracts) shot up like a rocket in response to what should have been a typical dip in the S&P 500. (rising almost 50 percent in just a few minutes).
Short VIX ETFs like XIV and SVXY were pushed to cover their positions in order to limit their losses. But what do you think happens if everyone tries to flee through the same tiny door at the same time?
Because the number of bets that everyone was attempting to avoid exceeded the market’s capacity, each deal was conducted at increasingly higher prices. That is, each trade to cancel a short bet (equivalent to going long the VIX) resulted in the VIX rising even higher. And, feeling the ETF managers’ desperation, traders on the other side were keen, like sharks tasting blood in the water, to get their pound of flesh.
The VIX had roughly doubled by the time everyone had finished trading, and investors who had substantial short VIX bets had lost nearly everything.
Here are a few Reddit comments that demonstrate the pain and anguish that this financial tragedy has caused investors:
“I’ve lost $4 million, three years’ worth of effort, plus the money of others.” Lilkanna u/Lilkanna u/Lilkanna u/Lil
“I sympathize with you because I’ve lost half of my net worth today T T I’ve probably lost 5 years of my life” u/asianhere u/asianhere u/asianhere u
“Correct me if I’m wrong, but my greatest lesson from the XIV fiasco is that if I want to start a ponzi scheme and include a disclaimer that says ‘you might lose everything,’ it’ll be fine, right?”
Mauimikes (u/mauimikes)
In the stock market, what is XIV?
Credit Suisse Group AG used to sell an exchange-traded note called XIV, the VelocityShares Daily Inverse VIX Short-Term ETN, which you could buy to wager against volatility.
Is it wise to invest in SVXY?
This index is a terrible trade even over short time periods. The index has fallen in 73 percent of all months during the last ten years, with the likelihood of losses growing as the holding period lengthens. Simply put, for the vast majority of traders, this index has not been a profitable investment over time.
What triggered the Volmageddon?
Bloomberg (Bloomberg) Don’t bother with a Bitcoin ETF. The most anxiously awaited exchange-traded funds are just as speculative and even more controversial for many Wall Street stock traders.
A new twist in a legal dispute has reintroduced short-volatility products, which ride calm markets. This comes at a time when at least three issuers are attempting to launch new funds.
Credit Suisse Group AG must confront claims that it caused the implosion of its VelocityShares Daily Inverse VIX Short Term notes (ticker XIV), the major event in an episode of 2018 upheaval dubbed “Volmaggedon,” according to a New York appeals court.
A market sell-off generated a jump in volatility, prompting Credit Suisse to recall the instrument, which was essentially a bet on falling equity price fluctuations. With nearly $1.9 billion in assets, its demise was thought to have exacerbated the selloff.
The Credit Suisse decision now risks reigniting the concerns that have dogged these risky but popular securities for years.
“The SEC’s main worry is undoubtedly avoiding a repeat of the VIX futures jump and liquidity meltdown of February 5, 2018,” said Vance Harwood of consulting firm Six Figure Investing. He explained that the occurrence was “likely attributable to the leveraged ETPs’ rebalancing demands.”
The US Securities and Exchange Commission approved Volatility Shares LLC’s -1x Short VIX Futures ETF in March before quickly issuing a letter effectively putting the action on hold while it is investigated.
Dynamic Shares Trust looks to have received approval for its Dynamic Short Short-Term Volatility Futures ETF as well, albeit the product still needs to clear further SEC obstacles.
Another short-volatility product hopeful, Simplify Asset Management, has yet to file a registration statement.
The question in the Credit Suisse legal battle is whether the bank intended for trades in futures contracts for the Cboe Volatility Index, or VIX, to cause XIV’s value to plummet.
Is a leveraged VIX ETF available?
Leveraged Volatility ETFs provide investors a bigger piece of the CBOE Volatility Index (VIX). Through the use of financial instruments such as swaps, futures, and other derivatives, these ETFs are designed to provide enhanced returns based on the VIX.
Is it possible to short VIX?
- Its value tended to rise during severe market downturns, earning it the moniker “Fear Index.”
- For those who shorted it (shorting is a bet that an investment will drop in price thus if you short the VIX, you win money when it goes down and lose money when it goes up), it was a major source of riches. The VIX was so popular as a trade that it even has its own subreddit.
Is there an inverse VIX?
Investors can use inverse VIX exchange-traded funds (ETFs) to wager against the future direction of market volatility. The most extensively used volatility benchmark is the Cboe Volatility Index (VIX), also known as the market’s “fear gauge.” To move in the opposite direction of the VIX, inverse VIX ETFs employ complex financial methods. Increasing economic uncertainty can produce negative investor mood, which can lead to increased volatility. The price of inverse VIX ETFs declines as volatility rises. When uncertainty fades and optimism returns, volatility reduces, which can boost the value of inverse VIX ETFs.
What is the VIX’s polar opposite?
One of the most popular ways to play the trend was using the VelocityShares Daily Inverse VIX Short-Term ETN (XIV). Because it is based on the inverse of the VIX, it provided investors with consistent gains during this time of severe market quiet.
The markets began to correct in early February, and volatility soared. The VIX jumped from 12 to 50 in a matter of trading days, and the value of XIV plummeted. On February 5th, 2018, the value of XIV plummeted by more than 90%, effectively wiping out investors.
What is the antonym of Vxx?
The inverse of the Volatility index, the XIV trades up when volatility is low. This year, that’s been a great bet. However, these high-volatility products should be used with caution.
Let’s have a look at VXX. The VIX is down 37% this year, while the VXX is down 68%.
Huh? The VXX’s structure is the problem, and as a result, it’s usually always a money loser when held for longer periods of time. Because the VXX owns the VIX futures contract for the first month, this is the case. The front month contract on these vehicles is continuously rolling over into the following month term. The VIX curve is usually always in contango, meaning that futures that expire later are more expensive. That means you’ll continue to lose money over time as the ETN purchases more expensive contracts. Even if spot volatility is unchanged, you continue to lose money! Ouch!
So, what exactly is the point of having VXX? It can be a lucrative technique to earn money in a short amount of time.
These instruments, for example, are extremely volatile, and on particularly volatile days, the VXX will typically move more in percentage terms than the VIX. If you believe there will be a sharp increase in volatility in the coming days, the VXX could be an excellent method to gain outsized exposure.
One approach to counter this is to play the inverse of the VXX, which is the XIV. The XIV increases when volatility decreases. You’re basically betting on the VIX futures staying in contango, and you’re getting compensated for it.
Recently, a lot of individuals have been betting on low front-month volatility. That’s why the XIV has seen a lot of activity in recent months.
Of course, the inverse is true for the XIV: if volatility rises, the XIV will fall quickly.
Here’s a more difficult question: why are VIX futures in such a high level of contango? September’s spot VIX is 18.65, November’s is 22.27, and January’s is 25.20.
One reason is that many of these volatility funds have futures positions in certain contracts! As these funds grow in size, they are required to roll over a higher dollar value of those futures, resulting in more ownership…distortion!
Another reason is that the market is anticipating a slew of potentially turbulent events in the coming months, including European turmoil, the US presidential election, and the fiscal cliff. VIX futures may flatten down if these events occur with relatively little disturbance, but they are unlikely to invert and move into full backwardation.
Another common question I receive is, “Why can’t you own the cash VIX?” Why isn’t there an instrument that can exactly reproduce the VIX? The VIX is only a formula for calculating implied volatility. It tracks the price of S&P 500 options (puts and calls) in the near term…to replicate that index, you’d have to regularly purchase and sell those near-term options; transaction costs would be enormous. It isn’t possible.
Another caveat: these are both Exchange Traded Notes, which are solely backed by the company’s credit rather than assets maintained in a custodial bank, as is the situation with an Exchange Traded Fund (ETF).
What does the term “Volmageddon” imply?
The unprecedented U.S. stock market activity on February 5, 2018, was dubbed Volmageddon, a combination of the phrases volatility and Armageddon.