Always A Change Of Storms With Volatility ETFs

Always A Change Of Storms With Volatility ETFs

Investors need to understand the nature of short-term VIX funds like XIV and SVXY.

Reviewed by: Russell Rhoads
Edited by: Russell Rhoads

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.


Triggering Price Reversal

However, there is another side to this story, which occurs when the stock market comes under pressure. The S&P 500 selling off quickly often results in VIX and VIX futures moving up sharply. This price action can put extreme pressure on the value of XIV and SVXY. Therefore, before considering buying either fund, investors should be aware of the full history of XIV and SVXY performance.

XIV was created in late 2010, and SVXY followed in late 2011. For a performance discussion, I’m going to use XIV, since there is more history to work with, but the performance of SVXY and XIV are usually in lockstep with each other. For example, as of March 17, SVXY is up 56.2%, and XIV is up 57.3% for the year.

The table below shows the monthly performance for XIV running from 2011 through 2016. Note that for the six full years of data available, XIV was down three years and up three years. In 2012 and 2013, XIV managed phenomenal performance. 2014 and 2015 were down years, and 2016, again, was a very strong year.

I also broke out monthly performance for XIV on this table to highlight what sort of ride owning either of these funds may be. Each year, there is at least one month where these short funds lost 10%. Four of these six years had a month where there was a 20% loss, and there are even a few months where this strategy loses more than 30% in a single month.

Both XIV and SVXY are easy methods for all levels of traders to get exposure to a short market-volatility strategy.

Over time, this sort of trading and investing has proven to be profitable, but this is over the long term. Selling volatility has been equated to the Wall Street phrase, “Picking up nickels in front of a steam roller,” which basically means you’ll make some consistent profits, but get run over periodically.

The volatility events that will put pressure on XIV and SVXY usually are quick and unexpected. If you decide to invest in either fund, just be aware that periodically there are going to be some setbacks. This knowledge may help you ride out the storm and benefit from a short-volatility fund over the long term.

You can reach Russell Rhoads at [email protected]. At the time of writing, the author had no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.


Russell Rhoads is director of education at the CBOE Options Institute.