How Does VelocityShares’ ZIV Work?

Updated: Jul 29th, 2018 | 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 short side side of that trade. VelocityShares’ ZIV is an Exchange Traded Product (ETP) that allows you to hold a short volatility position while avoiding some of the issues associated with a direct short position in VXX.  Because ZIV is tied to VIX futures with at least 4 months until expiration its daily percentage moves are considerably smaller than the moves of funds (e.g., VXX, UVXY, TVIX) that are tied to shorter term, more volatile VIX futures.

To have a good understanding of how ZIV works (full name: VelocityShares Daily Inverse VIX Medium-Term ETN) you need to know how it trades, how its value is established, its characteristics, its risks, and how VelocityShares (and the issuer— Credit Suisse) make money running it.

How does ZIV trade?

  • ZIV 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 120 thousand shares, ZIV’s liquidity is good.  Its bid/ask spread tends to run around 10 cents, which is on the high side, but as a percentage of its trading value that’s ~0.15% so it’s not a big economic penalty.
  • Unfortunately, ZIV does not have options available for it.  However, both of its closest Exchange Traded Fund (ETF) equivalents, REX ETF’s VMIN and ProShares’ SVXY -0.5X short term ETF do have options available.
  • Like a stock, ZIV’s shares can be split or reverse split—but unlike VXX (with 5 reverse splits since inception) ZIV has only split once, a 1:8 split in June 2011 that took its price from  $129 down to $16. Unlike Barclays VXX, ZIV is not on a hell-ride to zero.
  • ZIV 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 ZIV’s value established?

  • Unlike stocks, owning ZIV 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 ZIV.  While you’re at it forget about technical style analysis too, the major price moves of ZIV are not driven by supply and demand for ZIV itself but rather by the moves of the large, liquid VIX futures market.
  • Ultimately ZIV value is tied to the daily resetting inverse of an index (S&P VIX Medium-Term Futurestm) that specifies a hypothetical portfolio of VIX futures with 4 through 7 months until expiration.  Every day the index specifies a new mix of VIX futures in that portfolio. On any given day one-third of ZIV’s assets are allocated to VIX futures with 5 months till expiration, another third is allocated to 6th-month futures, and the final third is split between 4th and 7th-month futures. This mix of VIX futures gives ZIV the approximate performance of a VIX future with 153 days until expiration.
  • The index ZIV tracks, SPVXMP, is maintained by the S&P Dow Jones Indices.  The theoretical value of ZIV, if it were perfectly tracking the inverse of the index, is published every 15 seconds during market hours as the “intraday indicative” (IV) value.  Yahoo Finance publishes this quote using the ^ZIV-IV ticker. Because ZIV’s day end value is set by the settlement prices of VIX futures the closing IV value of ZIV is established around 4:15 PM ET not at the 4 PM NYSE close.
  • Wholesalers called “Authorized Participants” (APs) will at times intervene in the market if the trading value of ZIV diverges too much from its IV value.  If ZIV is trading sufficiently below the index they start buying large blocks of ZIV—which tends to drive the price up, and if it’s trading above they will short ZIV.  The APs have an agreement with Credit Suisse that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep ZIV’s tracking in good shape.  According to ZIV’s median tracking error relative to its index is -0.04%.

How Does ZIV Behave?

  • Almost all the time the medium-term VIX futures that underlie ZIV are in a configuration called contango where the longer dated futures are more expensive than the ones closer to expiration.  Persistent contango sets up an attractive short trade because as long as contango persists the VIX futures shorted by ZIV will tend to go down in value over time.  Contango does not guarantee profits for the short seller because if volatility spikes the medium-term futures tend to go up in unison but historically around 75% of the time ZIV is increasing in value.
  • This situation sounds like a short sellers dream, but VIX futures occasionally go on a tear, turning the short volatility trader’s profits into losses very quickly. While not as volatile as the short-term volatility funds ZIV can drop dramatically.  Its record one day drop so far was -26% on February 5th, 2018 and one day drawdowns of over 10% are fairly common.
  • The chart below shows ZIV from 2004 using simulated values.

  • ZIV does not implement a true short of its tracking index.  Instead, it tracks the -1X inverse of the index on a daily basis and then rebalances investments at the end of each day.  For a detailed example of what this rebalancing looks like see “How do Leveraged and Inverse ETFs Work?
  • There are some very good reasons for this rebalancing, for example, a true short can only produce 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”.  ZIV, on the other hand, is up almost 500% since its inception on November 29th, 2010, and it faithfully delivers a daily percentage move very close to -1X of its index.
  • Detractors of the daily reset approach correctly note that ZIV and funds like it can suffer from volatility drag.  If the index moves around a lot and then ends up in the same place ZIV will lose value, whereas a true short would not, but as I mentioned earlier, true shorts have other problems.  Surprisingly, if the underlying index is trending down, daily resetting ETPs can deliver better than their stated leverage performance.  For more see “A Hat Trick for Inverse / Leveraged Volatility Funds
  • Historically ZIV has median moves of -0.21X compared to the CBOE’s VIX index.  If the VIX moves up 10% you can expect ZIV on average to move down 2.1%.  However, this relationship is not cast in stone.  At times ZIV and VIX will even move in the same direction.
  • Another important statistical ZIV relationship is its typical moves relative to the short-term volatility index which big volatility funds like VXX, UVXY, and TVIX are tied to.  Its median beta, the ratio of ZIV percentage moves to VXX moves, is around -0.44.  This ratio varies but as the chart below shows the variation since VXX started trading in January 2009 has remained between -0.2X and -0.72X.


What are the Risks?

  • Along with their impressive upsides, inverse volatility funds like ZIV carry considerable risks. The risks include the inevitability of volatility spiking up during market scares, corrections, or bear markets. Since its inception in 2010, ZIV has experienced 30 single day drawdowns of -5% or more, including the previously mentioned -24% crash. As scary as this is the other inverse volatility funds -0.5X SVXY and VMIN carry even more drawdown risk with worse case one-day drawdowns of -48% and -38% respectively. Buying and holding these securities is not for the faint of heart.
  • Another risk is termination. ZIV’s prospectus states that if ZIV drops 80% or more in a single day it will likely terminate. Before February 2018 there was a lively debate on whether this was a credible risk even for the higher leveraged former -1X short term inverse funds XIV and SVXY—which were much more likely to terminate than ZIV.
  •  On February 5th, 2018 both XIV and SVXY dropped more than 90%.  XIV was subsequently terminated by Credit Suisse and SVXY was deleveraged by ProShares down to -0.5X.  Based on that day’s behavior it would take a one-day VIX spike of over 300% to put ZIV in risk of termination (the 5-Feb-2018 VIX spike was 115%).  If VIX futures became even more reactive than they were on the 5th it might require a lower VIX jump than that but the bottom line is that it would likely take an event equivalent or bigger than the October 1987 crash to terminate ZIV.


How do VelocityShares and Credit Suisse make money on ZIV?

  • Credit Suisse collects a daily investor fee on ZIV’s assets—on an annualized basis it’s 1.35%.  With current assets at $120 million, this fee brings in around $1.6 million per year.  That should be enough to cover Credit Suisse’ ZIV costs and be profitable.  My understanding is that a portion of this fee is passed onto to VelocityShares for their technical and marketing activities.
  • Unlike an Exchange Traded Fund (ETF), ZIV’s Exchange Traded Note structure does not require Credit Suisse to report what they are doing with the cash it receives for creating shares.  The note is carried as senior debt on Credit Suisse’s balance sheet but they don’t pay interest on this debt.  Instead, they promise to redeem shares that the APs return to them based on ZIV’s daily closing indicative value.
  • Credit Suisse could hedge their liabilities by shorting VIX futures in the appropriate amounts, but they almost certainly don’t because there are cheaper ways (e.g., over-the-counter swaps) to accomplish that hedge.

With XIV delisted and SVXY deleveraged ZIV has a comparable leverage factor with the remaining inverse volatility funds (VMIN, and -0.5X SVXY).  Historically it has declined less than its competitors on the really high volatility days (5-Feb-2018 and Brexit shocks).  ZIV can’t guarantee that advantage in the future but it is comforting to see a track record of smaller drawdowns during historic VIX spikes.  In the post-February 2018 volatility landscape, ZIV is an attractive choice for shorting volatility.

 For more information 

Simulation of the Longer Duration VMIN & VMAX

Updated: Jun 29th, 2018 | Vance Harwood | @6_Figure_Invest

When they were introduced by REX ETF in May 2016 VMIN and VMAX were the first actively managed volatility Exchange Traded Funds (ETFs).  REX’s strategy was to offer higher effective leverage than the popular unleveraged long VXX and the daily resetting inverse volatility funds (XIV & SVXY).  In 2017 REX ETF’s strategy paid off with VMIN delivering an eye-popping 190.6 percentage gain, bettering XIV & SVXY returns by 4.7%. For more on how VMIN and VMAX worked during that timeframe see this post.

Then Came February 5th, 2018…

XIV plunged 96%  on February 5th, 2018.  Since VMIN’s expressed strategy was to offer higher leverage than XIV you’d reasonably have expected VMIN on that date to drop below zero and be terminated—but it didn’t die.  It “only” dropped 87%.

How is that possible?

Most likely the managers of VMIN recognized that the end of day VIX futures settlement on the 5th was likely going to be disastrous, and covered at least some of their VIX future short positions before the typical rolling/ rebalancing trade time of ~4:15 PM ET.  By acting preemptively they avoided the worst of the VIX Future’s end-of-day spike—and dodged what would have been a likely death blow to VMIN.

Reflection often follows a near-death experience and that was the case with REX ETF also.  Given the record VIX percentage move and unprecedented level of correlation of the VIX futures with the VIX during the spike, they reasonably concluded that they should reduce the leverage of their funds.  Starting March 7th REX ETF started shifting allocations and reached their target leverage on March 23rd, 2018.


More Time until Expiration

In order to reduce their effective leverage, REX ETF changed VMIN & VMAX’s holdings to a rolling mix of 3rd, 4th, and 5th-month VIX futures.  The funds always hold 50% of their assets in the 4th-month futures and allocate the remaining 50% between the 3rd and 5th-months.  The 3rd vs 5thmonth holdings shift in proportion to the time remaining until the 3rd month becomes the 2nd-month future.  The last contracts in the 3rd-month futures are closed out the night before they become the 2nd-month futures. This algorithm results in a mix of VIX futures that have an effective duration of around 110 days.


The New Leverage Factors

Based on historical patterns this mix of futures should produce VMIN/VMAX percentage moves that are ~0.26 of the CBOE’s VIX’s percentage moves  (compared to 0.51 previously).  The comparable metric for Barclays’ VXX is 0.45.

VIX futures and the VIX index don’t always track well (sometimes they even go in opposite directions!) so another useful metric is how closely the new VMIN/VMAX will track VXX.  I simulated VMIN/VMAX performance, using its new allocation strategy, from 2004 on using the Cboe’s futures historical data.  Based on that simulation I’m estimating that the new VMIN/VMIN percentage moves (leverage) will typically be around 0.53X of VXX’s percentage moves.  While more consistent than the VIX percentage tracking, this leverage also varies somewhat because the VIX futures term structure between the 1st and 2nd months sometimes shifts relative to the 3rd through 5th months.  The chart below shows how that leverage has shifted historically when averaged over a calendar month period.


Drawdown / Termination Risk

My backtest also allows us to answer questions like how much the new VMIN would have dropped on 5-Feb-2018 (a -38% drop), how it would have fared through the 2008/2009 bear markets (drawdown of 85%), and 2011 correction (drawdown of 51%).  A chart of the simulation is shown below.

With this new allocation strategy, VMIN has a much lower risk of termination and reduced drawdowns during volatility spikes—at the cost of not harvesting contango as effectively as the funds with higher leverage.


Fees and Dividends

I have included REX ETF’s annual fees of 2.85% for VMAX and 3.46% for VMIN in the simulation.  I could not find any mention of Treasury bill interest in the prospectus so that is not included.

To comply with the securities act of 1940 VMIN and VMAX  must distribute any capital gains as dividends at least yearly.  I did not attempt to simulate this process, instead, the values shown are effectively adjusted for any splits and dividends assuming that any dividends distributed were immediately reinvested in the funds.



Time will tell whether 2018’s February 5th event was an aberration or foreshadowing of future volatility spikes.  The changes to VMIN/VMAX greatly increase their chances of complying with the number one rule of investing—no matter what; make sure you preserve capital to trade another day.


Simulation Spreadsheet

I am making my VMIN/VMIX simulation spreadsheet available for purchase.  The spreadsheet uses an index derived from the 3rd through 5th-month VIX futures and includes the formulas for computing annual fees and calculating the inverse daily resetting function of VMIN from that index.  The spreadsheet does not include the VIX Futures values or formulas for converting from the VIX futures values to the index.  If you cannot see purchase information below please click this link and look at the bottom of the page.

If you purchase the spreadsheet you will be directed to PayPal within a few minutes where you can pay via your PayPal account. When you successfully complete the PayPal portion you will be shown a “Return to Six Figure Investing” link. Click on this link to reach the page where you can download the spreadsheet.  Please email me at [email protected] if you have problems, questions, or requests.  It’s easy to miss the “Return to Six Figure Investing” link.  If you don’t get it / can’t find it please email me.

1.5X UVXY & -0.5X SVXY Open/High/Low/Close values: March 2004–March 2018

Updated: May 1st, 2018 | Vance Harwood | @6_Figure_Invest

Some volatility trading systems use intra-day open, high, low (OHL) prices as part of their algorithms for determining when to trade. UVXY and SVXY didn’t start trading until late 2011—just after the 2011 correction and well past the 2008/2009 bear market so there’s no actual trade data from those important downturns.

To fill that deficiency I did some simulations a few years ago using the OHL values of  VIX futures to calculate OHL data for many of the volatility Exchange Traded Products (ETPs) including UVXY and SVXY.

The Freaky Fifth of February

The events of February 5th, 2018 caused a death and some changes. In addition to XIV’s termination by Credit Suisse due to its losses that day ProShares decided to reduce the leverage factors on UVXY and SVXY. Those leverage changes took effect the 28th of February, 2018.

UVXY and SVXY’s ticker symbols did not change so the publically available OHLC data is a mix of the old 2X and -1X and new 1.5X and -0.5X leverage factors—the data before February 28, 2018, only applies to the discontinued leverage factors.  For people wanting to do simulations on the new funds based on historical data, this is a problem. To address this need I did simulations for the 1.5X UVXY and -0.5X SVXY to generate the OHLC data from March 2004 through March 2018—these are available at the bottom of this post and here.

The New IV Close Values

Generating the simulated Indicative Value (IV), the ~4:15 PM ET close values for the new 1.5X UVXY and -0.5X SVXY was straightforward, I adjusted the appropriate multipliers in the algorithms and used the official VIX futures settlement values as inputs into the calculations. The resulting IV Close results match closely (within +-0.15%) to the values published by ProShares on the web pages for UVXY and SVXY.

Generating Open/High/Low data for the Reduced Leverage UVXY & SVXY ETPs

Using the combination of the OHL for the original funds and reduced leverage IV close values I generated simulated OHL data for the reduced leveraged funds.

The process I used was relatively straightforward. I assume that for the 1.5X leveraged UVXY the intraday percentage moves from the previous day’s IV close would be reduced by ratio of the leverage changes (1.5/2 or 0.75 for UVXY). For example, if the old UVXY open was 3% higher than the previous day’s IV close the simulated open for the new 1.5X fund would be 2.25% higher than the previous 1.5X UVXY IV close. See the end of the post for an example equation.

Using the same approach, the new SVXY open values would be 50% (0.5/1.0) of the old SVXY’s OHL opening percentage moves relative to the previous day’s closing IV value.  This same calculation was used for computing the intraday high and low values.

The source OHLC data that I use starts in March 2004 and has a major transition on 28-Oct-2013. On the October 2013 date, I switched from using VIX futures to simulate the OHL values to using the publically available trade dat.  O the October date the Cboe extended the trading hours of the VIX futures to the extent that they were no longer a good proxy for the normal NYSE trading hours. See this post for a detailed discussion on why I made the transition and the various uncertainties involved.

The 4 PM “Fake Close”

With historic trade data, there is also a “close” price in addition to the open/high low data. This close number is the last trade before or at the 4 PM market close of the equity markets—however, SVXY & UVXY official close isn’t until around 4:15 PM ET when their underlying securities, the two next to expire VIX futures settle.

Most brokers disseminate the 4 PM number as the “Close”. This causes no end of confusion—I’ll call this 4 PM close the “Fake Close” (FC). Often there are significant moves in the volatility markets in the remaining 15 minutes of trading—which can result in big differences between the Fake close and the IV close values. The leveraged ETPs rebalance is based on the IV close values so if you use the FC value for your calculations you will often conclude that the ETPs are not moving with the correct leverage the next day (see If you think your ETP is broken ).

While the Fake close generates confusion it does have one redeeming quality—it gives us one more piece of intraday data at an interesting time.

Action at the End

The Fake close allows us to better characterize the last 15 minutes of trading—on days with big volatility moves there is often a lot of action in this time window. The graph below shows the historical UVXY percentage moves in the 15 minutes from Fake close to the IV close.


The 102% move on 5-Feb-2108 was a 29 sigma move—a good indicator that assuming a normal distribution for $UXVY day end percentage moves is a really bad idea…  For more on outsize sigma moves see: Not All High Sigma Events are Black Swans.

Revised Daily High & Low Numbers

The publicly available trade data assumes that trading stops at 4 PM, so the stated high and low data may be inaccurate—because new lows and highs can be reached in the last 15 minutes of trading (and often are). In my simulation, if the IV close is lower than the trading low or higher than the trading high I set the intraday lows and highs to the IV close value as appropriate. Of course, the prices may have moved to higher highs or lower lows than the IV close during those 15 minutes but that trade data is not freely available.

Adjusting the February 5, 2018 data

Using old UVXY & SVXY OHLC data to generate simulated values for the new 1.5X and 0.5X funds is defendable for every day from March 26th, 2004 through February 27th, 2018– except for February 5th, 2018.

On that day the VIX set a new one day close-to-close record with a +116% jump (the previous highest was +62%) and the mix of VIX futures that UVXY and SVXY track (index SPVXSP) jumped +96% (the previous highest jump was +33%).  I won’t go into the details, I’ll defer that to another post but the bottom line is that the managers of UVXY and SVXY correctly predicted that the end of day settlement for VIX Futures would be the apex of a liquidity crisis and chose to buy VIX futures to do their required rebalancing before the VIX Futures closed. This meant that the funds ‘performance likely would not track their target index but in the end, counterintuitively, saved both the 2X long and -1X inverse shareholders money.

In an alternative universe, had the reduced leverage 1.5X UVXY and -0.5X SVXY been trading on February 5th the fund managers would probably not have started early with their rebalancing so my simulation used actual VIX futures settlement values to simulate the end of day values on February 5th, 2018 for the lower leverage funds.


 An important lesson, illustrated by the February 2018 travails of XIV and SVXY, is that when you’re testing trading strategies, you shouldn’t assume that past relationships (e.g., VIX percentage moves relative to VIX Futures percentage moves). will hold in the future. It’s critical to ask what can happen, especially when systems are highly stressed. It’s not enough to just look at the past.



Example Conversion Equation

New_Openday  = New_IV_Closeday-1* (1+1.5/2.0*(Old_Openday / Old_Closeday-1   -1))

Where:  New = 1.5X UVXY
Old = 2X UVXY

Purchase Information

If you purchase one of the spreadsheets below you will be eventually be directed to PayPal where you can pay via your PayPal account or a credit card. When you successfully complete the PayPal portion you will be shown a “Return to Six Figure Investing“ link.    Click on that link to reach the page where you can download the spreadsheet.  Please email me at [email protected] if you have problems, questions, or requests.

How Did the Old -1X SVXY Work

Updated: Apr 21st, 2018 | Vance Harwood | @6_Figure_Invest


As of February 28th, 2018 SVXY will target -0.5 leverage instead of -1X.  This change was in response to the events of February 5th, 2018 when a massive VIX futures spike occurred in the last 30 minutes of trading, probably in part due to the rebalancing required by the 2X UVXY and -1X SVXY funds.  This change to SVXY will reduce its rebalancing requirements and make it less susceptible to a termination event if VIX futures were to increase 100% or more from the previous day’s close.  This leverage change will reduce SVXY’s performance when VIX futures are dropping in value.  Proshares Press Release


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 did -1X SVXY trade?

  • SVXY trades like a stock. It can be bought, sold, or sold short anytime the market is open, including premarket 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 three 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.
  • SVXY is subject to termination risk.  Termination can occur (and did with XIV, a very similar fund on February 5th, 2018) if the daily positive move in the VIX futures market approaches or exceeds a 100%.  ProShares guarantees that SVXY will not go negative so to protect themselves they will cover their short positions and terminate the fund if things get bad enough.  For more on this see XIV Termination.

How was  -1X 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 with a leverage factor of -0.5X, so for example, if the index (ticker SPVXSPID) moves up 0.3%, then SVXY will move down precisely 0.15%. 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 did -1X 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 moneymaker and the rest of the time it is giving up much of its value in a few weeks—drawdowns of +90% are not unheard of. The chart below shows SVXY from 2004 using actual values from October 2011 forward and simulated values before that.


  • Understand that SVXY did not implement a true short of its tracking index. Instead, it attempted to track the -1X percentage inverse of the index on a daily basis.  To maintain this -0.5X 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”.  -0.5X SVXY, on the other hand, would be up over 200% if it had been trading since the original -1X SXVY started trading 3-Oct-2011.  It faithfully delivers a daily percentage move very close to -0.5X of its index.
  • Detractors of the daily reset approach correctly note that SVXY and funds like it 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.


How did ProShares make money on -1X 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 $1 billion, this fee brings in around $9.5 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 $400 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 $20 million (5% of $400 million) of capital that evening. If SVXY goes down 10% the next day, then another $18 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. -91%! in the Jan/Feb 2018  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.

The eye-popping inverse volatility gains in 2016 and 2017 pushed SVXY’s assets beyond VXX’s but with its February 5, 2018 reset it dropped well below that level. It will be interesting to see how the next few years go.  I suspect we’ll see additional bloodletting as people rediscover short volatility can be very volatile in its own right.

How Do Bitcoin Futures Work?

Updated: Jan 21st, 2018 | Vance Harwood | @6_Figure_Invest

The CME and Cboe/CFE, two large, well respected, USA regulated futures exchanges, recently started trading Bitcoin futures. These venues make it possible to trade on Bitcoin’s value without being exposed to the uncertainties of the mostly unregulated Bitcoin exchanges.

To understand Bitcoin futures you need to recognize, among some other things, that these futures are not in the business of predicting Bitcoin’s price.

Bitcoin Futures are Not Trying to Predict the Future!

It’s reasonable to assume that a product named a future is attempting to predict the future. For Bitcoin futures, this is definitely not what they deliver. The core utility of the futures markets is not predicting the future prices of their product but rather the secure delivery of a product at a known price, quality, and date. If there’s product seasonality (e.g., specific harvest times) or foreseeable shortages/abundances then future’s prices may reflect that but neither of these factors applies to Bitcoin.

I’m not saying that Bitcoin futures won’t be used by speculators making bets on Bitcoin—they certainly will be— but when you see Bitcoin futures trading higher or lower than the current Bitcoin exchange values (spot value) it’s not a prediction—it’s a reflection of the inner workings of the futures market.

How Are Bitcoin futures prices established?

If you look at the quotes for Bitcoin futures you’ll see at least three things, the expiration code (shorthand for a specific expiration date ) the bid (buy price) and the ask (sell price). If you’re ever confused as to which one to use in your situation it’s easy to sort out—start with the price that’s worse for you.

Important agents interacting with those prices are operating in one of three roles: individual speculator, market maker, or arbitrageur. A key role is market maker—a firm that has agreed to simultaneously act as both a buyer and seller for a specific security. When companies sign up for this role they agree to keep the bid/ask prices relatively close to each other—for example even if they aren’t keen on selling Bitcoins at the moment they can’t just set the ask price to an outrageous level. The agreed-upon maximum bid/ask ranges might be tied to market conditions (e.g., wider when deemed a “fast market”) and might allow time-outs but in general, the market maker agrees to act as a buffer between supply and demand.

The Market Makers

The existence of market makers (e.g., Virtu Financial) refutes a common assertion about futures—that there‘s always a loser for every winner, that it’s a zero-sum game. It’s true that derivatives like stock options and futures are created in matched pairs—a long and a short contract. If two speculators own those two contracts the profits on one side are offset by losses on the other but market makers are not speculators. In general, they’re not betting on the direction of the market. They act as intermediaries, selling to buyers at the higher ask price and buying from sellers at the lower bid price— collecting the difference.

Market makers are challenged in fast markets—when either buyers or sellers are dominating and prices are moving rapidly. When this happens market makers are obligated to continue quoting bid and ask prices that maintain some semblance of an orderly market. If they start accumulating uncomfortably large net long or short inventories they may start hedging their positions to protect themselves. For example, if they are short Bitcoin futures they can buy Bitcoin futures with different expirations or directly buy Bitcoins to hedge their positions. The hedged portion of the market maker’s portfolio is not sensitive to Bitcoin price movements—their profit/losses on the short side are offset by their long positions.

The market maker’s ability to hedge out their exposure demonstrates that futures aren’t inherently a zero sum gain. They can accommodate the market and still be profitable—regardless of the market’s direction.

The Arbitrageur

The arbitrageur is hyper-focused on the price difference between the Bitcoin future and the exchange price. If those prices differ enough they can lock in risk-free profits. You can imagine how much capital is available if risk-free profits are in the offing…

The arbitrageur very carefully calculates the costs of buying or shorting Bitcoin futures while selling short or buying actual Bitcoins.

These calculations include:

      • Time value of money required for margin deposits
      • Fees
      • Transaction costs (bid/ask spread)
      • Contract expiration settlement price risk (Bitcoin futures are cash settled)
      • Borrow costs for shorting Bitcoin if going short
      • The amount of profit that their bosses expect from them.

Normally commodity futures arbitrageurs have to account for things like storage costs (e.g. warehouses, silos), insurance (in-case the storage facility is robbed or burns down), and seasonal price variations but none of these apply to Bitcoin, so somewhat ironically the crazy Bitcoin market is simpler for them.

Knowing their estimated costs and profit requirements the arbitrageur determines a minimum difference they need between the futures’ prices and the spot price before they will enter the market. They then monitor the price difference between Bitcoin futures and the Bitcoin exchanges and if large enough they act to profit on that gap.  For example, if a specific Bitcoin future (e.g., February contract) is trading sufficiently higher than the current Bitcoin exchange price they will short that Bitcoin future and hedge their position by buying Bitcoins on the exchange. At that point, if they have achieved trade prices within their targets, they have locked in a guaranteed profit. They will hold those positions until contract expiration (or until they can cover their short futures and sell Bitcoins at a profit).

They’ll do the complementary transaction if the price of a specific future is enough lower than spot price. They’ll buy futures and short Bitcoins to lock in profits in that case.

Arbitrageurs provide a critical role in futures markets because they’re the adults in the room that keep futures prices attuned to Bitcoin exchange prices. If there are multiple futures providers (Cboe and CME in this case) they’ll also act to keep the futures from the various exchanges aligned with each other.

If Bitcoin futures prices get too high relative to spot arbitragers are natural sellers and if the futures prices get too low they are natural buyers. Their buying and selling actions naturally counteract price distortions between markets. If they’re somehow prevented from acting (e.g., if shorting Bitcoin was forbidden) then the futures market would likely become decoupled from the underlying spot price—not a good thing.

The Term Structure

A key attribute of a futures market is how its contract’s prices vary by expiration date. The succession of futures prices over time is called the “term structure”. If supply is stable (no seasonality or shortages) then typically futures prices will increase with expirations further in the future. This term structure configuration is called “contango” and it accounts for the fact that carry costs (e.g., time value of money) and profit expectations increase with time. Unless there are big changes in interest rates or the way that Bitcoin exchanges work I expect the level of contango in the Bitcoin futures term structure to be small. Bitcoins don’t cost much to hodl (once you have your hardware wallet) and there’s no apparent seasonality. The chart below from VIX Central shows a typical Bitcoin term structure (click on chart to get current data):

Cboe vs CME: Sizes & Settlement

There are two USA regulated Bitcoin futures exchanges in operation. The CME’s contract unit is five Bitcoins whereas the Cboe’s contract unit is one—that’s the biggest difference between these futures. The upfront money to buy or sell short a CME contract will be about five times higher than the Cboe contract. Larger investors won’t care but this will be an issue for smaller investors. Another difference is the spot/settlement process that the exchanges use. In the case of Cboe futures, the contracts will be settled to a 4 pm ET Gemini exchange auction price on the day of expiration, for the CME futures the settlement price is a complex calculation using an hour of volume weighted data from multiple exchanges (currently Bitstamp, itBit, Kraken, and GDAX). With the CME’s approach, it will be harder to manipulate the settlement price but it doesn’t give arbitrageurs a physical mechanism to trade their positions—possibly an issue.

There’s nothing to prevent people from closing out their contracts before final settlement but typically there is some premium remaining until the very end.

Unlike many commodity futures, Bitcoin futures are cash settled rather than physically settled.  Cash settlement is a relatively new development in futures trading, first introduced in 1981 for Eurodollar futures, that addresses the problem of how to settle futures contracts on things that are difficult/impossible to deliver physicially—things like interest rates, large stock indexes (e.g., S&P 500), and volatility indexes (Cboe’s VIX).  Futures physical settlement involves actual shipment/change of ownership of the underlying product to the contract holder but in practice, it’s rarely used (~2% of the time).  Instead, most organizations that are using futures to hedge prices of future production/usage will make separate arrangements with suppliers/customers for physical delivery and just use the futures to protect against contrary price changes.  In practice, the final settlement price of the contract can be used to provide the desired price protection regardless of whether the futures contract specifies physically delivery or cash-settlement.

While “physical” delivery of Bitcoins as part of a futures contract would certainly be possible it raises regulatory and security issues in today’s environment where the cybercurrency exchanges are mostly unregulated, somewhat unreliable, and theft due to security hacks is distressingly common.  By selecting cash settlement the CME and Cboe completely avoid the transfer of custody issues and shift those problems to somebody else—namely the market makers and arbitrageur.


One traditional attraction of trading futures is the ability to use relatively small amounts of money to potentially achieve outsized returns. In many futures markets the margin, the amount of money that your broker requires up-front before executing the trade can be quite small compared to the ultimate value of the contract. For example, as of 22-Dec-2017, each E-mini S&P 500 contract was worth $134K ($50*S&P 500 index value)—this “list price” of the contract is called its notional value.  The CME only requires you to maintain a minimum margin of $4.5K (3.4% of notional) to control this contract (brokers often require additional margin). Margin requirements this low are only possible because the volatility of the S&P 500 is well understood and your margin account balance is adjusted at the end of every trading day to account for the winnings or losses of the day. If your account balance falls below the margin minimum of $4.5K you’ll need to quickly add money to your account or your position will be summarily closed out by your broker. On the plus side, if you’ve predicted the S&P’s direction correctly your profits will be that same as if you completely owned the underlying stocks in the index. A +1% daily move in the S&P500 would yield $1340 in profit even though you only have $4500 invested— a 29% return—this multiplier effect is called leverage.

Currently, Bitcoin futures have very high margin requirements. The Cboe requires 40% of the notional amount for maintenance margin, the CME requires 43%. Your broker will likely require more than that. The culprit behind these high requirements is Bitcoin’s high volatility—until that calms down the exchanges will protect themselves by requiring a bunch of up-front money. If you don’t come up with the money for a margin call they want to close out your position without leaving a negative balance.

Because of the high margin requirements, Bitcoin futures don’t offer much leverage compared to just buying Bitcoins outright. However, Bitcoin futures do offer the trader time-tested exchanges that are not nearly as susceptible to hacks, thefts, and unscheduled downtime.


In the movie “Trading Places,” there’s a wild scene where fortunes are made and lost in the orange juice future pit in a matter of minutes. This scene epitomizes what most of us envision futures trading to look like. The movie depicts a situation where the supply of oranges from the next harvest is unknown—and that is the source of the craziness.

Bitcoins don’t have seasonal variabilities—supply is a known quantity. This supply stability makes Bitcoin futures a lot less dramatic but in the case of Bitcoins this is a real plus—there’s already plenty of drama in the exchanges—the futures market will be the safe and quiet space. A different sort of trading places…