Short Volatility Products Halted This Week Amid Sudden VIX Spike (XIV)

On the social media forum Reddit, trading the XIV had proved so popular that it had earned its own forum called "tradeXIV". The prospectus outlines the procedure for shutting down the short-VIX product if it falls more than 80% intraday.

If that weakness extends into regular trading, investors will likely be stuck once again combating the double whammy of lower stocks and spiking volatility.

Credit Suisse, which is the biggest holder in one of the products, is down more than 6% in after-market trading.

They're referring, of course, to the Ocala, Florida-based former Target manager who made waves last year with claims that he'd grown his net worth from $500,000 to $12 million in five years by shorting the Cboe Volatility Index (VIX).

In 2016, the bank took its leveraged oil-tracking notes off of exchanges without offering all of its investors a way to redeem them, forcing some to trade "over-the-counter", where there was no guarantee of recouping their full investment.

Both of them use VIX futures contacts.

The S&P 500 had not fallen by more than 5 percent for more than 400 days, the longest run since the 1950s, according to Mark Haefele, chief investment officer at UBS Wealth Management.

Normally, one-month futures contracts on the VIX trade at a discount to the spot price, a structure known as backwardation.

For a fledgling asset class whose idiosyncrasies are understood by few, there sure is a lot of money swirling around in volatility trades.

But thanks to years of generally low volatility, in part due to money printing and bond-buying policies pursued by the world's major central banks, investors have shoveled billions of dollars into so-called "carry trades" that often depend on financial calm persisting for long periods. But volatility, which had spent much of a year ago below 15, also began to spike up and on Monday it blew out to 37 while the S&P 500 fell 4 percent.

I've spent the last day talking to traders trying to reconstruct what might have happened.

The repercussions have been severe for some funds.

Credit Suisse, the issuer of the VelocityShares ETN, in which it has a 32 percent stake, said on Tuesday it would redeem the ETNs.

A similar fund run by Nomura Securities is being liquidated after it crashed. This leverage creates a unique situation where the assets under management of the funds decrease as the VIX rises.

The spike in volatility does open up some attractive options market opportunities. That sentiment sent traders scrambling into XIV and rival inverse volatility products.

During its rapid surge higher, the VIX outpaced the VSTOXX, an event analysts flagged as an extreme move, also suggesting there would be a rapid normalization.

The events weighed on the stock of the Cboe itself, down 10 percent on Tuesday as people anxious about how its VIX-related trading volume and revenue will be affected by the implosion of these products.

Cboe Global Markets, which derives a portion of its revenue from volatility-related trading, will naturally see revenue from ETF and ETNs that short the VIX dry up, as investors turn away from the strategy in light of large losses.

  • Anthony Vega