Selling volatility has been a sure money maker since Donald Trump was elected president some 14 months ago. But that all came undone last week when a jaw-dropping rise in the CBOE VIX obliterated one inverse volatility product.
Trading of the VelocityShares Daily Inverse VIX Short-term exchange-traded note (XIV) will officially cease on Feb. 20, according to Credit Suisse, the product’s issuing bank. XIV, which is designed to give the opposite return of the CBOE VIX Volatility Index, nosedived Feb. 5, triggering an “acceleration event” for the fund.
“On the acceleration date, investors will receive a cash payment per ETN in an amount equal to the closing indicative value of XIV on the accelerated valuation date,” Credit Suisse said in a statement. “The last day of trading for XIV is expected to be February 20, 2018.”
The XIV collapsed because of an unprecedented rise in the VIX. The so-called “fear index” spiked 115% on Feb. 5 for its largest ever single-day advance. Because XIV is designed to perform inversely with the CBOE VIX, it trades in the same direction as the S&P 500 Index – only at three-to-five times the speed.
U.S. stocks just rounded out one of their worst weeks since the financial crisis, with the S&P 500 Index plunging more than 5%. Losses of this magnitude were enough to spike the VIX and tank products that offer inverse exposure.
Prior to last week, the XIV had dramatically outperformed the broader market, with returns of 1,200% since inception in 2010. By comparison, the S&P 500 had doubled over the same period.
To get a sense of just how dramatic the fall in XIV was, consider that the fund had nearly $1.9 billion in assets on Jan. 31. Just six days later, total assets had dwindled to just $110 million.
The XIV had at least two other close calls over the years, the first being in 2011 when the United States had its credit rating downgraded by Standard & Poor’s. As the stock market plunged, XIV fell 71% over a three-week period. A similar loss happened in 2015 after China’s devaluation of the yuan triggered a global panic sale in equities. In both instances, the XIV managed to recover.
The equity market’s massive slide put other volatility-related funds on the rope, including the ProShares Short VIX Short-Term Futures (SVXY). The fund is trading at a mere fraction of where it was more than a week ago, although ProShares has assured investors the product was doing what it was meant to do.
The fund manager told clients following the Feb. 5 crash that “the performance on Monday [Feb. 5] of the ProShares Short VIX Short-Term Futures ETF (SVXY) was consistent with its objective and reflected the changes in the level of its underlying index.”
Although XIV and SVXY have almost identical characteristics, the former is an ETN and the latter is an ETF. But this difference has nothing to do with SVXY surviving the “Black Monday” crash. Despite its apparent vulnerabilities, the decision to continue SVXY was a management one. However, there is no guarantee it too won’t be terminated in the future. Based on the stock market’s recent performance, another test of volatility could be just around the corner.
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