IVOP and XIV termination events


Updated: Mar 11th, 2017 | Vance Harwood | @6_Figure_Invest

In the prospectuses for  XIV, there are some disconcerting discussions about termination events. For XIV the termination event is triggered if the daily percentage drop exceeds 80%. I did some digging into these events to try and figure out how likely they are to occur.  If you’d like to read a more general discussion about this ETN you can read this post.

First of all  XIV provisions for termination/acceleration relate to volatility futures not the CBOE’s VIX index. The VIX relates to the instantaneous implied volatility of the S&P 500—which is a different thing. Volatility futures have contracts with different expiration dates. Typically the further out their expiration dates (e.g., 6 months from now), the slower they react to the day-to-day moves of the market. XIV is based on the two futures contracts that are closest to expiration, the administrators for these funds adjust their positions in these contracts daily to achieve an effective average time till expiration of 30 days.

VXX does the same thing, except it is trying to be long volatility, not short/daily inverse % of volatility. When trying to understand XIV you can view them as being a short position in VXX , or tracking the opposite daily percentage move of VXX (XIV).

VXX is not as volatile as the VIX index. On a day with sharp market moves VXX will typically move about half the percentage move of what VIX does. VXX can still make big moves however—one day during the May 2010 Flash Crash, it jumped almost 25%—the VIX on that day jumped 46%.

Now we can talk about termination / acceleration. I think it is reasonable to assume that the goals of the ETN providers in including these measures are to:

  • Prevent the ETN value from going negative (they specify in these prospectuses that the value will stay positive)
  • Protect the provider from undue market risk in hedging these products during volatile times

With XIV termination (or “acceleration” in marketing speak) relates to daily percentage moves. If VXX jumped more than 100% in a day, then if VelocityShares didn’t terminate XIV its notational value could go to zero.   They avoid this particular unhappy situation by terminating the fund if the daily move of VXX is 80% or more—although losing 80% in one day would still be plenty traumatic.

Just to be clear, this fund isn’t tied directly to VXX, but rather the underlying futures contracts, but I believe VXX is a good proxy for the situation.

The termination risk for XIV appears to be limited to market crashes worse than the Flash crash. Two examples that come to mind are the 2009 crash and the October 1987 crash. VXX didn’t exist for either of these. I have analyzed VIX data (or simulated data) since 1992—there were 20 days with VIX jumping over 30% (previous day close to intraday high) during that period. The highest percentage jump over that period was 70.5% on February 27, 2007. There were three days with VIX jumps over 30% in the 2008/2009 crash, and during the Flash Crash.

If VXX had existed during this time span and held to its typical behavior of 50% of VIX’s move it looks like the XIV termination event would not have occurred, but obviously it would have taken heavy losses on those days.

If you are investing significant amounts of money in these products it looks prudent to at least hold some OTM VIX or VXX  calls. These would provide some insurance against these infrequent, but dramatic events.

Thanks to Steve, who commented on the first version of this post pointing out that the ETN providers were probably not looking out for the investor, but rather for their own hides in incorporating these termination events.

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Saturday, March 11th, 2017 | Vance Harwood
  • Steve

    “The goal of these measures is to avoid the situation where the investor loses more than they invested.”

    I don’t think that the investor can lose more than they invested in this. I imagine these are so that the ETN sponsor doesn’t lose out.

  • Steve

    By the way, enjoy the blog.

  • vance3h

    Hi Steve,
    Of course you are right. I guess I’ve had short selling on the brain. I’ll update the post to correct the error.

    Thanks!

    — Vance

  • Pingback: Are Other Volatility ETFs At Termination Risk? - iCloudDNA()

  • jones

    Has anyone else noticed a huge amount of erosion of the XIV during the last week or so? what happened here? te erosion is supposed to be in the VXX because of the contango and the XIV investors should benefit from it.
    So what is going on now? suddenly the VXX investors are enjoying the erosion?
    can anyone give an explaination to this phenomenon?

  • Richard

    Hi Vance,

    With regards to termination events, wouldn’t ZIV be significantly safer than XIV given that its volatility is about 50% that of XIV?

    I’d also be interested in seeing a back tested analysis of ZIV vs XIV. I suspect ZIV has a higher Sharpe ratio than XIV looking at its recent performance.

    Also, I realise that ZIV has lower liquidity than XIV although it’s volume seems to be steadier than XIV’s too – XIV has dropped off a lot recently.

    Finally, a small correlation analysis between these two etfs and SPX shows that ZIV is currently a better diversifier if you have an equity portfolio. Admittedly the history is short and again, I’d like to backtest to get a better idea of how the correlation varies over time.

  • Vance

    Hi Richard,
    I did a backtest of ZIV to 2005 in this post: http://sixfigureinvesting.com/2011/06/backtesting-velocityshares-ziv-medium-term-inverse-volatility-etn/ In that post I refer to another blog that did a similar backtest of XIV. Counter-intuitively XIV seemed to do better. I agree that ZIV should be safer but current historical data does not support that for the pre-2008 crash time period. One hypothesis I have is that the contango on medium term futures was much less then than it is now. It could be the 2008 crash has created semi-permanent contango in the medium term futures.

    — Vance

  • Marcelo

    How do you insurance yourself with VXX calls? Let’s say I have 900 shares of XIV valued $23000 (XiV 25.8, VIX 16.5)

  • Did you mean VIX calls or VXX calls?

  • Jim

    no such thing as VIX calls

  • Hi Jim, While it’s true that there are no calls on VIX itself there are widely available calls on VIX futures, which are usually referred to as “VIX calls”. On yahoo finance type in the ^vix symbol, and then look at the options link on the left.

    — Vance

  • Mike

    Vance, what happens if they terminate XIV? they liquidate the fund at the threshold price and pay you back that amount/share?

  • Hi Mike,
    With XIV an 80% move down in indicated value during the day triggers the termination–which distributed using the closing value for XIV for the day.

    — Vance

  • dph

    Vance,

    Does it seem that it would need a 140-160% type daily move in the VIX then to terminate “XIV” since you suggest that VXX likely moves around half that?
    And has such moves ever occurred in the new or old VIX calculations (1987)?

  • HI dph,

    Yes, I think you’re right–the 2x % factor seems appropriate. The 1987 crash would have probably generated an absolute value of VIX of around 120. Since the 1987 was concentrated on a 1 day event it would have almost certainly terminated a XIV type fund. The old VXO predecessor to the VIX went from a close of 36 to a close of 150 on the 19th of October. I think the largest % spike in the VIX since then has been around 64%.

    http://www.thestreet.com/story/12778353/1/the-vix-had-one-of-its-biggest-spikes-in-a-decade-stocktwits.html

    — Vance

  • dph

    Makes sense. Apparently black swans do exist. That’s crazy that the old VXO went up 400%+. Thus we can likely assume that even half that move would wipeout the XIV. In your opinion what’s the best way to hedge a XIV position?

  • May

    Vance, nice post on the termination condition for xiv. When I go back to 2011 and checked the price of vxx, it was around 750 on Nov 18,2011 while the vix was around 37. How could the vxx be so much bigger than vix if it were to track the vix futures? May

  • Hi May,
    For starters read http://sixfigureinvesting.com/2013/04/how-does-vxx-work/ . If you still have questions let me know .

    — Vance

  • Marc

    Hi Vance, Your blog is a great resource – thank you for sharing your insights. Question – could the ProShares’s SVXY also have a “termination event” similar to the XIV?

  • Hi Marc, There is nothing in the prospectus except for the generic “The Trust, or, as the case may be, a Fund, may be dissolved at any time and for any reason by the Sponsor
    with written notice to the shareholders.”. I think ProShares would terminate the fund rather than let it go negative, as a self protective action. I don’t see any way ProShares could require investors to kick in additional money if its value went below zero.

    — Vance