Stock market volatility is back and it may have already claimed its first casualties. A pair of inverse volatility ETPs plummeted early this week after a spike in the Cboe Volatility Index (VIX) devastated the value of their underlying futures holdings.
The VIX skyrocketed by 115.6% on Monday as the S&P 500 fell by 4.1%. That’s the largest one-day increase in the VIX ever, according to Cboe.
Inverse VIX ETFs like the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and the ProShares Short VIX Short-Term Futures ETF (SVXY) were hammered by 14% and 32%, respectively, during normal market hours on Monday. Then they fell by another 80% after the close of trading as VIX futures continued to soar.
Boom To Bust
"It's unusual to have the kinds of moves we've seen today and after hours in the inverse vol complex,” said Dave Nadig, CEO of ETF.com “But it's worth pointing out, these funds did essentially what they've been designed to do from the beginning―provide short-term speculative vehicles for betting against volatility.”
“The moral of the story is―pretty much as it always is―to know what you own, why you own it and what your expected outcomes are,” he added.
Inverse VIX ETFs performed phenomenally during the past year as volatility declined to a record low. The VIX, which measures the implied volatility of near-term S&P 500 options, fell to as little as 8.56 in 2017.
The continual decline in volatility, along with roll yields from shorting volatility futures in contango, juiced the returns for XIV and SVXY. Both funds gained more than 181% in 2017, which even prompted Harvard’s endowment to take a small position in the latter late last year.
Before Monday’s plunge, the two products had a combined $4.1 billion in assets under management. But after Monday’s spike in the VIX, the two could be left with nearly nothing.
XIV and SVXY both promise to deliver -1x exposure to near-month VIX futures contracts. As of the close on Friday, both products held February 2018 and March 2018 VIX contracts at a proportion of 36% and 64%, respectively.
On Monday, the February contract jumped 112.6%, while the March contract rallied 86.8%. That translates into a weighted-average decline of 96.1% for the two products―nearly a complete wipeout.
According to the VelocityShares website, the latest net asset value for XIV on Monday stood at $4.22, down from $115.55 on Friday. Meanwhile, ProShares’ website pegged the NAV for SVXY at $3.96, down from $103.73.
What took place in the VIX and VIX exchange-traded products this week was truly unprecedented. Before Monday, the biggest one-day move in the VIX was 64.2%, which occurred in February 2007.
Cumulative Returns for 6 Factors Across Economic Stages (%)
|Biggest One-Day Up Moves For VIX Index
(Jan 1990-Feb. 5 2018)
|1||Feb. 5, 2018||115.6%|
|2||Feb. 27, 2007||64.2%|
|3||Nov. 15, 1991||51.7%|
|4||Jul. 23, 1990||51.5%|
|5||Aug. 8, 2011||50.0%|
|6||Jun. 24, 2016||49.3%|
|7||Aug. 21, 2015||46.4%|
|8||May 17. 2017||46.4%|
|9||Aug. 24, 2015||45.3%|
|10||Aug. 10, 2017||44.4%|
Sources: Cboe and Bloomberg (www.cboe.com/VIX)
Even during the financial crisis of a decade ago, the VIX never had a one-day increase anywhere close to that seen on Monday (though the absolute level of the index was much higher, peaking around 90 in October 2008).
To understand how sudden and unexpected Monday’s spike in the VIX was, consider this. March VIX futures were trading up by as little as 10.9% at 3:30 p.m. Eastern time. Half an hour after that, they were trading up 48% and 10 minutes later, they were up 95%.
ETFs Not To Blame
Hindsight is 20/20, but perhaps it shouldn’t be surprising that the worst time to short volatility turned out to be when the VIX was coming off a year of record lows.
Moreover, as devastating as the drop in these inverse volatility ETFs may be for anyone caught on the wrong side of the trade, they don’t necessarily spell the end of the short volatility trade, and definitely not the end of ETFs.
Follow Sumit Roy on Twitter @sumitroy2