How Does SVXY Work?


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

Just about anyone who’s looked at a multi-year chart for a long volatility fund like Barclays’ VXX has thought about taking the other side of the trade. ProShares’ SVXY is an Exchange Traded Fund (ETF) that allows you bet against funds like VXX while avoiding some of the issues associated with a direct short.

To have a good understanding of how SVXY works (full name: ProShares Short VIX Short-Term Futures ETF) you need to know how it trades, how its value is established, what it tracks, and how ProShares makes money with it.

How does SVXY trade?

  • SVXY trades like a stock.  It can be bought, sold, or sold short anytime the market is open, including pre-market and after-market time periods.  With an average daily volume of 8 million shares its liquidity is excellent and the bid/ask spreads are a few cents.
  • SVXY has options available on it, with five weeks’ worth of Weeklys and strikes in 50 cent increments.
  • Like a stock, SVXY’s shares can be split or reverse split—but unlike VXX (with 4 reverse splits since inception) SVXY has done two 1:2 splits to bring its price down into optimum trading levels. Unlike Barclays VXX, SVXY is not on a hell-ride to zero.
  • SVXY can be traded in most IRAs / Roth IRAs, although your broker will likely require you to electronically sign a waiver that documents the various risks with this security.  Shorting of any security is not allowed in an IRA.

How is SVXY’s value established?

  • Unlike stocks, owning SVXY does not give you a share of a corporation. There are no sales, no quarterly reports, no profit/loss, no PE ratio, and no prospect of ever getting dividends.  Forget about doing fundamental style analysis on SVXY. While you’re at it forget about technical style analysis too, the price of SVXY is not driven by its supply and demand—it is a small tail on the medium sized VIX futures dog, which itself is dominated by SPX options (notional value > $100 billion).
  • The value of SVXY is set by the market, but it’s closely tied to the daily percentage moves of the inverse of an index (S&P VIX Short-Term Futurestm) that manages a hypothetical portfolio containing VIX futures contracts with two different expirations. Every day the index methodology specifies a new mix of VIX futures in the portfolio. On a daily basis SVXY moves in the opposite direction of the index, so for example, if the index (ticker SPVXSPID) moves up 0.3%, then SVXY will move down precisely 0.3%. This post has more information on how the index itself works. The index is maintained by S&P Dow Jones Indices.
  • As is the case with all Exchange Traded Funds, SVXY’s theoretical share value is just the dollar value of the securities and cash that it currently holds divided by the number of shares outstanding. This theoretical value is published every 15 seconds as the “intraday indicative” (IV) value. Yahoo Finance publishes this quote using the ^SVXY-IV ticker. The end of day value is published as the Net Asset Value (NAV).  The NAV is computed at 4:15 ET, not the usual market close time of 4:00 ET, because VIX Futures don’t settle until 4:15.
  • If the trading value of SVXY diverges too much from its IV value wholesalers called Authorized Participants (APs) will normally intervene to reduce that difference. If SVXY is trading enough below the index they start buying large blocks of SVXY—which tends to drive the price up, and if it’s trading above they will short SVXY.  The APs have an agreement with ProShares that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep SVXY’s tracking in good shape.

What does SVXY track?

  • SVXY makes lemonade out of lemons.  The lemon in this case is the index S&P VIX Short-Term Futurestm that attempts to track the CBOE’s VIX® index—the market’s de facto volatility indicator. Unfortunately, it’s not possible to directly invest in the VIX, so the next best solution is to invest in VIX futures. This “next best” solution turns out to be truly horrible—with average losses of 5% per month. See this post for charts on how this decay factor has varied over time. For more on the cause of these losses see “The Cost of Contango”.
  • This situation sounds like a short sellers dream, but VIX futures occasionally go on a tear, turning the short sellers’ world into something Dante would appreciate.
  • Most of the time (75% to 80%) SVXY is a real money maker, and the rest of the time it is giving up much of its value in a few weeks—drawdowns of 80% are not unheard of. The chart below shows SVXY from 2004 using actual values from October 2011 forward and simulated values before that.

SVXY hist Aug16

 

  • Understand that SVXY does not implement a true short of its tracking index. Instead, it attempts to track the -1X percentage inverse of the index on a daily basis.  To maintain this -1X behavior the fund must rebalance/reset its investments at the end of each day.  For a detailed example of how this rebalancing works see “How do Leveraged and Inverse ETFs Work?
  • There are some very good reasons for this rebalancing, for example, a true short can only deliver at most a 100% gain and the leverage of a true short is rarely -1X (for more on this see “Ten Questions About Short Selling”. SVXY, on the other hand, is up 600% since its inception and it faithfully delivers a daily percentage move very close to -1X of its index.
  • Detractors of the daily reset approach correctly note that SVXY and funds like it (XIV) can suffer from volatility drag. If the index moves around a lot and then ends up in the same place SVXY will lose value, whereas a true short would not, but as I mentioned earlier, true shorts have other problems.  Even with volatility drag daily reset funds don’t always underperform. If the underlying index is trending down, they can deliver better than -1X cumulative performance. The chart below shows the relative one-year performance of SVXY and a true short starting with $1K invested in January for 2011 through 2016.

SVXYvsShort

How does ProShares make money on SVXY?

  • An Exchange Trade Fund like SVXY must explicitly hold the appropriate securities or equivalent swaps matching the index it tracks. ProShares does a very nice job of providing visibility into those positions. The “Daily Holdings” tab of their website shows how many VIX futures contracts are being held. Because of the -1X nature of the fund, the face value of the VIX futures contracts will be very close to the negative of the net “Other asset / cash” value of the fund.
  • ProShares collects a daily investor fee on SVXY’s assets. The fee is stated as a 0.95 annual fee, but it’s implemented by subtracting 0.95/365 of a percent from each share’s value every calendar day. With current assets at $280 million this fee brings in around $2.5 million per year. That should be enough to be profitable, however I suspect the ProShares’ business model includes revenue from more than just the investor fee.
  • Exchange Traded Funds like SVXY recoup transaction costs in a non-transparent way. Transaction costs are deducted from the fund’s cash balance—resulting in a slow divergence of the fund’s IV value from the theoretical value of the index that it’s tied to. This differs from the approach that Exchange Traded Notes (ETN) use, their theoretical value is directly tied to the moves of the index itself, so the ETN issuers must pay for transaction costs other ways (e.g., out of the annual investor fee, or other explicit fees). In the case of SVXY, this hidden transaction fee has averaged around 0.28% per year.
  • One clue on ProShares’ business model might be contained in this sentence from SVXY’s prospectus:
    “A portion of each VIX Fund’s assets may be held in cash and/or U.S. Treasury securities, agency securities, or other high credit quality short-term fixed-income or similar securities (such as shares of money market funds and collateralized repurchase agreements).”  Agency securities are things like Fannie Mae bonds. The collateralized repurchase agreements category strikes me as a place where ProShares might be getting significantly better than money market rates. With SVXY currently able to invest around $250 million this could be a significant income stream.
  • I’m sure one aspect of SVXY is a headache for ProShares. Its daily reset construction requires its investments to be rebalanced at the end of each day, and the required investments are proportional to the percentage move of the day and the amount of assets held in the fund. SVXY currently holds $280 million in assets, and if SVXY moves down 10% in a day (the record negative daily move is -24%, positive move +18 %) then ProShares must commit an additional $28 million (10% of $280 million) of capital that evening. If SVXY goes down 10% the next day, then another $25 million capital infusion is required.

SVXY won’t be on any worst ETF lists like Barclays’ VXX, but its propensity for dramatic drawdowns (e.g. 69% in the 2015/2016 timeframe) will keep it out of most people’s portfolios. Not many of us can handle the emotional stress of holding on to a position with huge losses—even though the odds support an eventual rebound.

It’s interesting that an investment structurally a winner albeit with occasional setbacks is not as popular as a fund like VXX that’s structurally a loser, but holds out the promise of an occasional big win.

It seems that people would rather bet on a correction, rather than the slow grind of contango.

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

    VXX and XIV cost the same this week – about $36. First time this has happened….ever. Buy the pair for $72.

    I dont see how the price for the pair can go lower.

    Do you?

  • Hi GB, This chart shows the non-split adjusted prices of VXX and XIV. The vertical lines are splits. I count at least 10 times that VXX’s price has equaled XIV’s. VXX has reverse split 4 times, so your charts are not reliable indicators of past trading prices. Unfortunately I can guarantee that the price of the pair will go lower than $72. XIV is not a true short of VXX, it is a daily resetting inverse fund. Between contango dragging down the price of VXX and volatility drag eroding XIV $72 dollars will not be a low. Eventually the combo might end up doing considerably better than $72, but the VXX part of it will be worth near zero.

  • GB

    VH- REally appreciate the prompt reply and the chart…i knew that splits were my wild card. Still…the logic may hold until the next split.

    i know about contango loss and vol drag….my bet is that those, relatively small, daily losses will be dwarfed by the sum of the pair when VIX spikes.
    Its really just dynamic hedging between the 2. Its far from perfect but its “not bad” because the prices are currently close.

    i refuse to believe its coincidence ….
    JUST/NUGT same price
    FAZ/FAS same price
    TMF/TMV sasme price (few weeks ago)

    direxion is gonna make a killing and i want a piece… just need to finish the math in 6hrs…. Korea tested a nuc cuz the market needs a reason to drop tomorrow.

    tnx again!

  • GB

    also note that VXX/UVXY = exactly 2.

  • GB

    and the august 13 2015 split was a week before the crash…and they equalized the prices of vxx and xiv…..the recent split achieved the same goal.

  • Fernando

    There is a risk of closure in XIV if the VIX rises too much in one day. Could the same thing happen with SVXY although it is an ETF which invests in VIX futures?

  • The threshold for XIV termination is if the futures index drops 80% in a day. For SVXY the prospectus does not explicitly state a threshold, but they reserve the right to terminate the fund for any reason, and they also state that the fund’s NAV can’t go below zero. The VIX futures that SVXY is short could take the fund into negative value if the futures jump enough, so it’s certain they would terminate the fund if it starts approaching zero.

  • ALP

    Vance,
    Your articles have been extremely helpful to me in understanding how VIX-related derivatives work.
    If Credit Suisse went bankrupt, since XIV is an ETN, I think any XIV shares I held would be worth $0.
    If ProShares went bankrupt, or decided to terminate SVXY, since SVXY is an ETF, I think there would be underlying assets to back the SVXY shares, and I would recover something, if not the full value of the SVXY shares.
    Am I understanding this correctly?
    Thanks,
    ALP

  • Hi ALP, I agree with your analysis. The XIV note is debt that’s higher priority than the Credit Suisse stock holders, but in bankruptcy it’s still reasonable to assume that there wouldn’t be an value left. The assets held in SVXY are tied to the SVXY shareholders so a ProShares bankruptcy should not materially impact the balances there. In general I think anyone paying attention should be able to exit these funds before a bankruptcy occurred.

    I think a far more likely risk for someone holding an inverse volatility product is if an overnight geopolitical / natural disaster occurs or a intra-day flash crash that spikes the VIX.

    — Vance

  • Matt Bowen

    Hi Vance – Thanks so much. This really helps me. Can you explain what happened in August 2015 and why SVXY had a more severe correction than HVI.CA for 2 weeks? I am in Canada and trying to understand what happened during that time (HVU seems to be a steady upward trend over the past 5 years) where SVXY had that more nasty correrction. I know there will always be ups and downs, but SVXY has not recovered to the August 2015 highs, but HVI has.

  • Hi Matt, Most likely the divergence is because HVI’s index uses the 4PM ET values of the underling index SPVXSP as the close values instead of the 4:15PM values that SVXY and XIV use. This link provides more detail http://www.horizonsetfs.com/horizons/media/pdfs/Educational/The-Mechanics-of-HVI-HVI-Explained.pdf This may seem hard to believe but there can be a lot of market dynamics in that time period. The other factor may be currency hedging impacts.

    Vance

  • Greg

    Hi Vance
    Should we be conceared that the market is up the last few days and Svxy is down? Is this a sign that it is time to get out. I really value your opinion as you are an expert in this field.
    Thank you for your help
    Greg

  • Hi Greg, The risk factors are definitely higher when the VIX & VXX start going up even when the market is up. It’s a sign that people are hedging heavily Of course people are often wrong, and it is notoriously tough to call the tops.

  • HI Greg,
    The June 27, 2011 event was a 8:1 stock split (forward, not reverse split). I think VelocityShares was trying to get the price down to a more tradeable range. I’ve attached ZIV’s performance (using VIX futures data before ZIV’s inception) to show its 13 year history. https://sixfigureinvesting….

    Here is SVXY from 2004: https://sixfigureinvesting.com/wp-content/uploads/2017/03/svxy-2004.jpg

    Best Regards, Vance

  • Greg

    Thank You Vance I only wish I found this site before I invested in UVXY. You have been a great help.

  • chris kolker

    Vance,

    Thanks for the good synopsis. One thing I would like to add. K-1s are issued for SVXY as it is listed as a partnership. Any comment on this as a detriment to holding?

  • K-1s do add complexity to your tax return and it seems like they are always late to arrive, but my experience with them(not extensive) is that they don’t significantly change your tax burden. According the ProShares note (link below) it has section 1256 style treatment where all gains/losses are allocated as 60% long and 40% short term.
    http://www.proshares.com/faqs/volatility_commodity_currency_proshares_taxation_faqs.html queston one.