Russell Rhoads is the director of education at the CBOE Options Institute.
We are approaching the end of the first quarter of 2017, and in the financial world, this means many things. One of them is performance reviews for managers, and in the financial press, that is an opportunity to publish lists. Best-performing or worst-performing (insert funds, ETFs, stocks, managers, indexes or any other imaginable thing here) lists are eye-catching and attract readers.
They also often attract new investors chasing performance.
I’m writing this because two of the short VIX-related exchange-traded products, the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and the ProShares Short VIX Short-Term Futures ETF (SVXY), will be at the top of many performance lists—barring a huge spike in volatility in the form of higher VIX and VIX futures over the next few weeks.
As many investors and traders are attracted to funds that are exhibiting strong performance, it is worth exploring exactly what you get when you own XIV or SVYX. I group these two funds together because they basically follow the same strategy, but do so with slightly different structures.
XIV is an exchange-traded note and SVXY uses the ETF structure. Also, due to a call feature of XIV, there are no options available, while SVXY has a very active option market. Otherwise, they are pretty much the same.
Inverse Short Exposure To VIX
XIV and SVXY are inverse funds that consistently give a holder short exposure to VIX futures, not the spot VIX index. The exposure shifts from day to day, with the goal of maintaining an exposure of 30 days. The funds accomplish this by holding short positions in standard VIX futures that expire before and after this 30-day window.
For example, on Friday, March 17, the weighting for these funds was about 7% short March VIX futures and 93% in April VIX futures. The March contracts expire on the open on Wednesday, March 22, so the weighting is much greater for the April contracts. Upon expiration of the March contracts, the funds will hold April and May VIX futures, with the weighting shifting each day from April to May as April expiration approaches.
The reason traders find these funds attractive is that VIX futures typically trade at a premium to the spot VIX index. For example, on Friday, March 17, VIX closed at 11.28, March VIX closed at 11.80, and the April VIX futures finished the day at 13.15.
At expiration, the futures contract prices will converge with spot VIX, so when VIX is unchanged or even up a bit, the futures may lose value. This is a positive for funds like XIV and SVXY, and this type of price action has been a big contributor to the strong performance of both funds in 2017.