What Caused the Volatility Tsunami on 5-Feb-2018?

In the afternoon of February 5th, 2018, what looked like a bad day for a group of high flying volatility-based products turned into a devastating decline.  Four factors combined to ruin their day: A Flawed Architecture Relying on the Past to Predict the Future Billions Under Management A Record-Breaking VIX® spike Twenty-five minutes before the close of the New York Stock exchange on February 5th, …

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Goodbye VXX, Hello VXXB

Update 11-March-2019 VXX finished out its 10-year life with a closing value of $38.28 and $449 million in assets. Barclays’ replacement product, VXXB, has revved up nicely with rising volumes and assets (it’s at over $700 million now). Any VXX shares of record at end of day, January 29th, were converted to cash on the 30th. There was some speculation that the closeout of hedges …

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Using the VIX Futures Term Structure to Predict Volatility ETP Prices

Status quo forecasting is sometimes very easy to do.  For example, if you predict that tomorrow’s high temperature will be the same as today’s high, your estimate will be close to the actual high much of the time.  Predicting volatility Exchange Traded Products (ETP) prices is not so straightforward.

The VIX futures that volatility ETPs like VXX, SVXY, UVXY, and TVIX track are similar to stock options in that they have a time value that usually decaying.  Generally the longer the VIX future has until expiration the higher its price.  If you plot VIX futures prices versus time until expiration the chart often looks like the one below from VIX Central.  This curve is called the VIX Futures Term Structure.

The term structure curve can be relatively stable for significant periods of time—which raises the question of whether we can use the term structure to predict volatility ETP prices.

Even if the price vs time curve of the VIX Futures stays exactly the same, several underlying factors that impact the prices of the volatility ETPs are in a state of change.  For example:

  • The individual VIX future’s prices change as they approach expiration
  • The mix of VIX futures that determines the ETP values changes based on their time to expiration and their prices
  • The position size of VIX Futures held by the leveraged ETPs (e.g., TVIX, UVXY, SVXY, VMIN, ZIV) changes on a daily basis based on the previous day’s percentage moves

Assuming the VIX futures term structure is stable (including the Cboe’s VIX spot price) allows us to project how much decay/gain is “built-in” to the prices of the long/inverse volatility ETPs. This information can help us set strike prices for option strategies, set limit prices, and determine risk/reward parameters.  More than 80% of the time, the VIX Future Term Structure is in a configuration called contango, where futures with more time until expiration are priced higher than the “spot” VIX price.  While in contango, decay factors on long volatility funds like VXX, UVXY, and TVIX can be considerable as can the boost factors on inverse funds like SVXY, VMIN, and ZIV.

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Volatility ETP Price Projection Service

I am offering a Volatility ETP Projection Service that calculates future volatility Exchange Traded Product (ETP) prices assuming the current VIX futures term structure is stable.

In my post Using the VIX Futures Term Structure to Predict Volatility ETP Prices, I show how this approach can be used to produce statistically valid ETP price projections and ranges.

This forecast does not attempt to predict upcoming volatility spikes or slumps—it’s totally focused on the price trends that would occur with a static VIX futures term structure.

With a stable term structure (and a stable spot VIX), the VIX futures prices that underlie the volatility ETPs like VXX, VXXB, UVXY, and SVXY do change but they precisely follow the price/days-til-expiration curve.  The VIX Central chart below shows the closing VIX futures prices for August 23, 2018.  If the term structure is stable then the curve at the end of the 24th would have the identical price vs time shape but the blue data points, representing futures values, would all be shifted slightly down and to the left.

The VIX futures that underlie the volatility ETP are volatile creatures—tomorrow’s values can be dramatically different than today.  I’m not trying to predict those sorts of changes.  What I am computing is the decay or boost that the volatility ETPs experience if the term structure stays in a stable contango or backwardation configuration.  This calculation is not an easy problem—there are a lot of moving parts even when the market is stable.

Historically the VIX futures term structure has been in a contango configuration 80%+ of the time.  Contango fuels a situation where the long volatility ETPs like VXX, UVXY, or TVIX suffer from high decay factors.  Anyone that’s looked at their long-term charts will see the massive impact of those decays over the long run.

Because of the typical decay in long volatility products, short volatility trades are popular but the possibility of volatility spikes makes risk management an important concern.  By estimating median prices and +-1 sigma ranges traders have some analytical results that can help quantify payoffs and establish appropriate risk management thresholds.

The chart below shows a typical SVXY projection when the term structure has been in contango for a while.

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How Does VelocityShares’ ZIV Work?

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 …

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