Inverse volatility—the winner for Short Term is XIV


Friday, July 31st, 2015 | Vance Harwood

I used to share stock tips with my brother-in-laws. Before the tech crash I could offer up a few stocks I liked, and they would often make some money.  The crash painfully ended the easy money and I moved onto index funds. They didn’t think indexes were near as much fun.

One Easter one of my brother-in-laws asked what I was investing in.   My response was “inverse volatility.” I might as well have said pixie dust.  I stood there wondering where (or if) to start.   First you have stocks, then you have the S&P 500, then you options on the S&P 500, then you have implied volatility calculations, then you have futures on volatility, then you have ETNs with rolling mixtures of futures on volatilty (VXX), and then you have the inverse (or the short) of that.   We looked each other in the eye and wordlessly agreed that we wouldn’t start.

I like inverse VXX/VXZ investing.  It’s seldom boring and over the long run the advantage is on your side. Volatility has a return to mean behavior, and volatility futures are almost always in contango—which erodes the value of VXX. If you buy inverse volatility when the VIX is relatively high, your chances of making a good profit eventually are very good.

Currently there are only three viable choices in inverse volatility ETN/ETFs.  VelocityShares offers XIV (daily percentage inverse of VXX), and ZIV (daily percentage inverse of medium term VXZ)—both ETNs, and ProShares offers SVXY—same as XIV except it is an ETF.

Barclays offers the XXV and IVOP ETNs which emulate short positions in VXX, but they are essentially dead funds, with very low leverage and volume.   I don’t recommend them.  For the reasons why see this post.

In rating the Barclays, VelocityShare, and ProShares funds I think there are  four primary factors:

  • Liquidity (small bid-asked spreads, getting good fills on orders)
  • Leverage
  • Risk
  • Tax treatment

ZIV’s daily volume is generally  around 50,000 , and its spread runs in the 7 to 10 cent range—not great, but it can handle good size trades (thousands of shares), without getting jerked around.   At times ZIV has been my primary trading vehicle for inverse volatility.  Lots of zip, with lower drawdown risk than the short term products.   For more on ZIV see Trading Inverse Volatility with a Simple Ratio.

On leverage  XIV and SVXY are simple, there goal is negative one-to-one for VXX’s daily percentage moves. The leverage of XXV and IVOP is not so simple.

It turns out that the daily percentage leverage of a short position is a variable which changes as the equity changes in price. For example, if you short XYZ stock at $100, the first $1 move either way delivers 1X leverage—you gain or lose $1,which is +-1/100 = +- 1% . But the further you get from that initiating price, the more the daily leverage changes.

For example, imagine after you sell XYZ short at $100 it drops like a rock to $2/share. If it drops the next day from $2 to $1.5, it’s a 25% daily move—but the value of your short position only changes from $98  to $98.5 per share. That’s a 0.5% move and the leverage, 0.5%/25% is only  0.02X. Conversely, if XYZ moves to $150 after you short it at $100, a $1 daily move down (0.67%) changes your position value from $50/share to $51/share—a 2% move which is  2%/.67% = 3X leverage. The graph below shows this relationship.

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XXV, IVOP, XIV leverage vs VXX, click to enlarge

The drop off to zero leverage on IVOP and XXV  is Barclays’  “Automatic Termination Event” that stops out their inverse funds if they drop  below $10 per share. This prevents these funds from going negative. This termination is a real risk for the Barclay products, IVO was terminated in September 2011 when VXX went above $49.5 per share.

Barclays ETNs only have 1X leverage when VXX is at their inception price.  I think this is a terrible aspect of Barclays’ funds.  When things are going in your favor (volatility dropping) your leverage is dropping, and it climbs rapidly when volatility is spiking—the opposite of what you would like.  This loss of leverage as VXX declines forced Barclays to introduce IVO, because XXV leverage had dropped so low.  In the future as contango grinds away at the VXX value Barclays would need to introduce a follow-on to IVOP to get their leverage back up near the 1X range—but it looks like they are not going to do that. XIV is a clear winner on leverage.

Regarding risk, these are volatile products. They will get hammered when volatility spikes up. In the August/September 2011 correction XIV dropped from 19 to 6.5, a 66% drop in a few weeks. If the market goes into a major bear mode it might take a long time to recover your losses. Recent history has shown that daily percentage funds like XIV weather volatility spikes better than true shorts like IVOP, or the departed IVO.  XIV is a clear winner on termination risk—it is much less likely to automatically stop out investors.  See this post for more information on termination.

Although all inverse volatility funds benefit from the normal contango term structure of volatility futures,  they aren’t reasonable buy and hold choices for investors.  Investors should hedge, or go to the sidelines if the market looks “toppy”.   All your gains can evaporate in a big hurry if the market corrects or crashes.

Will Barclays respond to XIV’s growing success by introducing a 1X leverage fund? I doubt it. They have a great situation with XXV and IVOP—every dollar invested in these funds is a perfect hedge against their other short term volatility product: VXX.   They can skip the hedging expenses on both sides because they hedge each other, and Barclay can collect their 0.89% annual fee, risk free.

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Friday, July 31st, 2015 | Vance Harwood
  • http://www.sixfigureinvesting.com/blog Vance Harwood

    XIV won’t stay permanently depressed. It will do very well in strong bull markets. Downswings will continue to be very deep.

  • Jon

    Thank you! Last question. Could this do well in a bear market if volatility goes down? I.e. Is this a levered s&p instrument or tied to volatility? Could this go up if vol normalizes but the market remains in bear territory?

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Historically bear markets always have high volatility. XIV would not do well. The levered model works best in this case.

    — Vance

  • Phil

    Hi Vance,
    First off – thanks for the wealth of info provided, I’m a huge fan and an avid reader!! Question for you – I heard this version before “XIV/SVXY = Leveraged S&P”, but I’m not so sure I agree and would like to see why you think that way too? Typically XIV has huge tailwinds in form of contango and this I think already provides a big difference between it and the index, among other things. Thoughts? Thanks in advance!!!

  • Brian

    Hello. Can XIV ever go to zero outside of a one day spike in VIX above 200%? Thank you.

  • Brian

    HI just wanted to follow up with this question. Thanks.

  • Rodolfo

    Can you explain what happened to XIV today ? 25.08.15
    Totally out of synch with VIX and even with VXX !
    At the open VXX was -10% aprox and its supposed inverse was +4% , or so, while VIX was -30%.
    Buying XIV at yesterday’s Close ( 24.08.2015) didnt work at all today.

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    The problem was that most software uses the 4PM quote as the close from the previous day. This is inappropriate because the real close, coincident with the VIX futures these funds are based on don’t close / settle until 4:15. To see the correct % changes look at the IV quotes (e.g., yahoo ^XIV-IV). The ratio with VXX tracked as appropriate. The mismatch with VIX is another matter, the VIX futures market and the SPX options market that the VIX is based on aren’t linked that closely.

    — Vance

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Hi Brian, First of all XIV is not directly tied to the VIX, it’s based on VIX futures, which have a tenuous link to VIX except when the are set to expire. That being said a 200% move in the VIX would be about what it would take to hit the 80% termination point.. This article gives more information http://sixfigureinvesting.com/2011/06/ivo-and-xiv-termination-events/ XIV will get hit very hard in bear markets, but a quick death would have to be via a volatility spike.

    — Vance

  • Rodolfo

    Thanks Vance, but this quotes appeared live in TWS ( Interactive Brokers trading platform) I saw them this morning while trading. XIV was not VXX inverse today. At least that is what was shown on the screen.

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Was it the percentage change number you were looking at? Those use current prices referenced to yesterday’s close. My closing IV quotes for XIV / VXX show -.69%, +.68% –looks pretty inverse to me…

    — Vance

  • rodolfo

    Yes sir ! Must have been some problem with the platform. Thanks a lot for your answers.

  • Brian

    Thanks! One more question. On a day like today when volatility is down 15%, why is VXX up? Seems like it should be down. Thanks

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Hi Brian, Sometimes the SPX option market which drives the VIX value has a different opinion on things than the VIX Futures market which drives the volatility ETP products like VXX. It’s not clear if one market is more savvy than the other, but I favor the VIX futures market slightly.

    — Vance

  • Arnie Lucki

    Hi. Why was XIV down with the S and P up almost 4% today. That’s ridiculous?

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Sometimes the S&P and the S&P option market which drives the VIX value have a different opinion on things than the VIX Futures market which drives the volatility ETP products like XIV. It’s not clear if one market is more savvy than the other, but I favor the VIX futures market slightly. The VIXcentral.com site shows the movements of the VIX futures.

    — Vance

  • Arnie Lucki

    that doesnt explain why the VIX short term futures which XIV is based on was not significantly down on a 4% up day in ES.

  • Arnie Lucki

    XIV was pounded down to 22.5 from 48 during the 4 day crash last Thursday to this Tuesday. It’s now at 28. That is total nonsense. It should be over 35 at least if not 40.

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    The S&P and the VIX futures are independent markets, with no hard linkages. There is no “should” here. Volatility spikes up quickly and decays slowly, that’s the name of the beast.
    — Vance

  • Arnie Lucki

    There is no way they are independant. The evidence for that can be shown by overlaying S and P and VIX performance charts on a short , medium and long term basis.

  • Arnie Lucki

    Looking at those charts you can clearly see the strong inverse corelation.

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Hi Arnie, You’re right, those charts are generally inversely related. However it seems to me you have a decision to make. The market didn’t behave as you expected–that’s clear. As to what caused that situation you could assert some mistake has been made, or that there was some manipulation behind the scenes, or that the markets don’t work as you expected. If you are interested in pursuing the last option it might be useful to read this post: http://sixfigureinvesting.com/2014/01/patterns-predictions-correlation/

    — Vance


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