One of the hottest trades in recent memory, shorting volatility, evaporated in a heartbeat Monday. In the aftermath of an unexpected volatility explosion, Credit Suisse is moving to terminate the VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV).
The VIX, or so-called fear index, is a widely observed indicator for investor sentiment in the stock market and measures the expected or implied volatility of large-cap stock options traded on the S&P 500 index. ETPs that track VIX futures allow investors to profit during rising volatility or hedge against short-term turns.
Continue Reading Below
Amid Monday’s plunge in U.S. stocks, the VIX surged, but volatility exchange traded notes, such as XIV have a unique feature: The indexes these products track settle after the close of U.S. markets. In after-hours trading Monday, XIV suffered catastrophic losses. The ETN’s market closing Monday was $99, but its closing indicative price as listed on the VelocityShares website was just $4.22.
Intraday drops of 80% or more trigger termination events with XIV.
“If the price of the underlying futures contracts increases by more than 80 percent in a day, it is extremely likely that the Inverse ETNs will depreciate to an Intraday Indicative Value or Closing Indicative Value equal to or less than 20 percent of the prior day’s Closing Indicative Value and will be subject to acceleration,” according to a prospectus. “If an Acceleration Event occurs at any time with respect to any series of the ETNs, we will have the right, and under certain circumstances as described herein the obligation, to accelerate all of the outstanding ETNs of such series.”
“Credit Suisse — which is the largest holder of the ETN — issued a statement saying the bank has not suffered any trading losses due to the XIV implosion. Nevertheless, the Swiss lender this morning set a redemption date of Feb. 20, for the volatility note, well ahead of the Dec. 4, 2030, maturity date,” according to Schaeffer’s Investment Research.
Last year, traders argued that the VIX remained depressed because realized volatility in U.S. equities has diminished and economic fundamentals remain supportive. That sentiment sent traders scrambling into XIV and rival inverse volatility products. For example, XIV doubled in size in August.
ETNs are not exchange traded funds. Similar to index-based ETFs, ETNs also track some sort of index as part of their investment strategy. However, an exchange traded note, like the name implies, is a type of debt note that trades on an exchange. Consequently, investors are exposed to the credit risk or the possibility the underwriting bank.
For more information on the CBOE Volatility Index, visit our VIX category.
Continue Reading Below