Volatility Comes Roaring Back

Investors seldom see volatility like they have witnessed this year. By some measures, 2020 may actually go into the history books as being the most volatile on record, outdoing even the enormous stock market fluctuations during the Great Depression.

Consider this: The 16 sessions it took the S&P 500 to fall into bear market territory between February and March was the fastest pace in history (a bear market is considered 20% off the all-time highs).

The average daily fluctuation in March for the S&P 500 was a whopping 5%, eclipsing the 3.9% daily average for the index’s predecessor in November 1929.

Within the extreme volatility of March were some eye-popping single-session moves. Between March 9 and March 18, the U.S. stock market rose or fell by at least 4.8% in every session, a streak comparable only to periods during the Great Depression.

In those eight sessions, “Level 1” circuit breakers were triggered four times, halting market trading for 15 minutes each time.

What is more, the S&P 500 closed lower by 7.6% or more on three occasions in that stretch, making them three of the 20 largest single-session declines for the index. That includes a massive 12% drubbing on March 16, the third-biggest drop on record—outdone only by a 12.3% plunge during the Depression and 1987’s 20.5% swoon.

The free fall on March 16 pushed the Cboe Volatility Index (VIX) to a close of 82.7, a new record for the index widely considered Wall Street’s “fear gauge.

Volatility Goes Both Ways
This year’s volatility has not been one-sided, either. The stock market rebound in April and May was also one for the record books. In the 50 trading sessions between the S&P 500’s bottom on March 23 and June 3, the index gained 39.6%—the largest 50-day rally ever, according to LPL Financial.

Since peaking in March, the VIX, which measures the implied volatility of near-term S&P 500 Index options, has since declined to around 30. But that is still double where the volatility index was trading before the COVID-19 crash began.

The VIX tends to rise when stocks are falling (and vice versa), reflecting investors’ demand for hedging using options.

VIX ETP Returns
In addition to being a barometer of stock market hedging, the volatility index also underlies several popular exchange-traded products.

The ProShares Ultra VIX Short-Term Futures ETF (UVXY), the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX) and the ProShares Short VIX Short-Term Futures ETF (SVXY) are three of the most popular products in the space.

VXX provides exposure to VIX futures with an average maturity of one month; UVXY leverages up that exposure to 1.5x; and SVXY offers -0.5x inverse exposure to similar futures contracts.

On a year-to-date basis, UVXY was up 154% through the first six months of the year; VXX rallied 124%; and SVXY shed 51.7%.

At the high point for VIX futures in mid-March, UVXY was up as much as 758%; VXX was up 356%; and SVXY was down 60%.

Anyone who has held UVXY, VXX or similar notes has cleaned up, but timing is key for these ETPs. Because VIX futures are typically in contango, where later-dated futures contracts are more expensive than near-month contracts, VIX-tracking products tend to decay over time.

The decay is further compounded in leveraged VIX products, where daily rebalancing can be an additional drag on returns; case in point, UVXY is down 96% since its inception in 2017.

That is why these products are best left to short-term traders or sophisticated investors who use them for hedging or pair trades—not buy-and-hold investors.

YTD Returns For VXX, UVXY, SVXY

Data measures total returns for the year-to-date period through June 30, 2020

More Risks
Anyone who uses VIX ETPs should also be mindful that they can be altered on a dime. In February 2018, after the VIX doubled in a single session, a number of inverse VIX products were wiped out, while the aforementioned SVXY barely survived, and shifted from offering -1x leverage exposure to -0.5x exposure.

More recently, Credit Suisse announced that the VelocityShares Daily 2x VIX Short-Term ETN (TVIX), which, at the time of this writing, is the largest VIX product on the market, with $1.1 billion in assets, would be delisted on July 12.

Despite having more than $1 billion in assets and rising 147% this year, Credit Suisse has chosen to jettison TVIX from its balance sheet (ETNs represent a debt obligation of the issuing firm).

Low Vol Disappoints
Contrasting with the risky, high-flying volatility products that are popular among short-term traders is another group of volatility-linked products designed for risk-averse, long-term investors.

Low volatility ETFs like the $34 billion iShares Edge MSCI Edge MSCI Min Vol U.S.A. ETF (USMV) and the $8 billion Invesco S&P 500 Low Volatility ETF (SPLV) were meant to give investors a smoother ride while providing returns on par with the broader stock market.

For the past five years, that is largely worked. USMV and SPLV gained 79.4% and 71.5%, respectively, in the five-year period through 2019, compared to 73.8% for the S&P 500. They did that with slightly less volatility than the broader market.

However, this year, even though the pair has remained slightly less volatile than the market, they have notably underperformed. Through the first six months of 2020, USMV lost 6.5% and SPLV dropped 13.7%, sharply lagging the 3.1% decline for the S&P 500.

YTD Returns S&P 500, USMV, SPLV

Data measures total returns for the year-to-date period through June 30, 2020

The funds’ heavy weightings in financials and utilities, combined with only modest exposure to technology, have played against them. That has dismayed some investors who had hoped that low vol ETFs would better insulate them from this year’s market volatility.

While investors are not giving up on the strategy yet, they have been more patient with the better-performing USMV, which has only seen outflows of $197 million this year. SPLV has registered heftier outflows of $1.7 billion in the same period.

Contact Sumit Roy at [email protected]