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Todd Carlisle
I guess it's just a two post day but in doing research I came across something important that I wanted to share. Some of my posts you can totally ignore but this is on the important to know side of things. I want to discuss an event known as Volmaggedon that occurred in 2018 but more importantly the consequences of that event and how they affect you. "Volmageddon” is the nickname for the market crash of short volatility strategies on February 5 2018 that led to the demise of some inverse VIX exchange-traded products in the United States and continues to hold lessons for us today. A sudden rise in market volatility led to a one-day loss of more than 90% in the value of short volatility exchange-traded products (ETPs). See the market had found a cheat code of sorts. The VIX, aka the fear index, was created as a way of tracking volatility in options pricing. The thing about this is that if not for reverse splits funds tracking the vix would all eventually go to zero. All you need to do is check out $UVXY or $VIXM and look at a long-term chart to see the effect. But imagine if there was a fund that tracked the inverse of the vix. Not only tracked it but did so with a 2X ratio meaning for every $1 the vix dropped this fund would gain $2. Seeing as historically the vix has continued to decline any funds tracking the inverse would essentially be free money. Well that was very much the case up until February the 5th 2018. The two symbols in question were $XIV and $SVXY . On February 5, 2018, on the heels of rising rate expectations, the S&P 500 dropped 4.1% recording its largest one-day move since 2011. This ended 300 trading days without a downward move of more than -2% in the index. The VIX, in turn, recorded its largest-ever percentage increase (115%) closing at 37.32 from the previous day’s close at 17.31. Additionally, stock correlations increased and reached their highest levels since August 2015. On February 5, inverse short vix products were forced to rebalance their portfolios near the market close and in the after-hours market. This can result in a costly rebalance. For instance, suppose you have a $100 portfolio and you want short vix exposure with 1x leverage. This requires selling $100 of vix futures. Now suppose the vix increases and the exposure is now $150. The short vix portfolio is now worth only $50 making you 3x levered. To de-lever, the portfolio requires purchasing $100 of risk to maintain the 1x exposure desired. The more the vix increased, the more risk needs to be purchased to maintain the desired exposure. This brings me to the part that affects you. Notice how I've been referring to them as exchange traded products but not ETFs. That is because they are not ETFs they're a different structure entirely. This structure is known as an ETN. ETNs don't hold underlying securities, like stocks or bonds. They're unsecured debt instruments issued by a bank that promises to pay the performance of an index. Etn's are products that basically constitute an IOU. A great example of this is the Bitcoin fund by grayscale $GBTC. They're investing in Bitcoin and promising to pay you th e profits but you are not directly invested in Bitcoin because that's not allowed on the exchange. This promise to pay in the case of $XIV had a catch. $XIV had become popular because over the previous five years it had returned 2,200%. Then on Feb. 5, the VIX jumped 100%. Reports say the note's price was $72.59 at 4 p.m. ET and fell to $4.22 by 5:10 p.m. Because the note had lost more than 90% of its value, Credit Suisse enacted a provision the next day to close the ETN to prevent further losses. The provision was in the prospectus where any situation resulting in a loss of 70% or more would trigger a closure of the fund. This provided them a 30% buffer which they needed all but 10% of as $XIV and $SVXY fell an astonishing 90%. The triggering of the fund closure meant that it was a total loss for anyone invested. They were taken to court afterwards but the judge found that proper disclosure had been given. The fund manager stated "The publicly available prospectus accurately and fully disclosed the risks of an investment in XIV, which is only intended for sophisticated institutional clients. Credit Suisse did not engage in any conduct designed to mislead investors regarding XIV's value or cause the Feb. 5, 2018, decline in XIV's price." So what's the lesson here? I think it's pretty clearly to know what you're invested in. The fund is not responsible for making you read. Before getting into products that you do not understand you should take the time to understand them because no one saw Volmaggedon coming but I'm sure they'll never forget it. #volatility #vix #tcardizzle #investing101 #newbie
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