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Volatility ETFs Are Broken – $XIV Down 70% in After-Hours Catastrophe

23 points by ca98am79 9y ago

chollida1 9y ago
I mean leverage and inverse ETF's aren't broken, they are behaving as desired. You just should never, ever hold one overnight as per the SEC guidelines due to how they reset each night. https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm I can't think of a single valid reason to hold a leveraged ETF overnight. If anyone has one, please let me know:) The awesome KidDynamite blog goes into how these ETF's are re-balanced and how they can "rip your face off" if you don't understand them. http://kiddynamitesworld.com/leveraged-etf-trading-flow-case-study-gold-miners-gdx-nugt-dust/ http://kiddynamitesworld.com/leveraged-etf-trading-flow-case... http://kiddynamitesworld.com/leveraged-etfs-and-high-school-level-mathematical-truths/ http://kiddynamitesworld.com/leveraged-etfs-and-high-school-...
- fwdpropaganda 9y ago
  Hey, awesome links, thank you. I was just thinking that I should eventually get around to understading leveraged ETFs, XIV and such. And I end the day with an awesome new addition to my list of RSS ;-)
- MuffinFlavored 9y ago
  why to hold overnight? look at what XIV did the past 18 months and compare it to SPY :)
- Donald 9y ago
  This wasn't overnight decay (plus this is short vol, so contango works for you.) This was panic selling as XIV neared its terminal drawdown point.
- snthpy 9y ago
  Nothing too mysterious in the examples in the SEC Alert link. One just has to keep in mind that these ETFs leverage the daily return and then take into account the compounding effects. If you have an index with normally distributed returns with mean m and volatility v, then the long term compound return c is c = m – 0.5 v^2 . An ETF which leverages k times will have returns with mean km and volatility kv. The ETFs long term compound return e will be e = (km) – 0.5 (kv)^2 = k m – k^2 0.5 v^2 = k (m – 0.5 v^2) – (k^2 – k) 0.5 v^2 = k c – k (k – 1) 0.5 v^2. For k > 1, the second term will always be negative so the ETFs return will always be less than the leveraged compound return of the underlying index. Whether the leveraged ETF return will be more or less than the underlying index return depends on whether c > (k – 1) 0.5 v^2 <=> m – 0.5 v^2 > (k – 1) 0.5 v^2 <=> m > k 0.5 v^2 <=> m / (0.5 v^2) > k. In other words, the leverage k has to be kept less than the m / (0.5 v^2) which is the well known Kelly Criterion.
tveita 9y ago
I don't know if this is a recent phenomenon or if I just haven't known where to look before, but after the stock fall I'm seeing links to remarkably unsophisticated "investors communities" of a kind I'd only seen for cryptocurrencies before. The description of these XIV derivatives just screams "run" to me, they're pretty much guaranteed to eventually drop to 0 if you hold them long term. Maybe they have some sort of hedging purpose in n-dimensional financial chess, but there's no way they should have been part of someone's personal portfolio. And yet I've heard multiple tales of people trading them, even on margin! I'm reservedly optimistic about trading platforms like Robinhood, but maybe in the end they'll turn out to be just another way to funnel dumb money into a bubble.
joezydeco 9y ago
XIV is dead. https://www.marketwatch.com/story/credit-suisse-announces-plan-to-liquidate-xiv-inverse-volatility-etn-2018-02-06 https://www.marketwatch.com/story/credit-suisse-announces-pl...
hcknwscommenter 9y ago
I just don't get it. Broken? The darn thing has done almost exactly what it was designed to do. VIX futures went up after hours, way up, and XIV went way down. That is how an inverse VIX futures product is supposed to work. I would buy some right now if they hadn't announced liquidation. People are acting like the ability of a product to go to zero, or close to it, should be a deal breaker, i.e., that such products should not exist. That is crazy. Individual common stocks go to zero (bankruptcy) all the time.

23 points by ca98am79 9y ago

I mean leverage and inverse ETF's aren't broken, they are behaving as desired. You just should never, ever hold one overnight as per the SEC guidelines due to how they reset each night. https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm I can't think of a single valid reason to hold a leveraged ETF overnight. If anyone has one, please let me know:) The awesome KidDynamite blog goes into how these ETF's are re-balanced and how they can "rip your face off" if you don't understand them. http://kiddynamitesworld.com/leveraged-etf-trading-flow-case-study-gold-miners-gdx-nugt-dust/ http://kiddynamitesworld.com/leveraged-etf-trading-flow-case... http://kiddynamitesworld.com/leveraged-etfs-and-high-school-level-mathematical-truths/ http://kiddynamitesworld.com/leveraged-etfs-and-high-school-...

fwdpropaganda 9y ago
Hey, awesome links, thank you. I was just thinking that I should eventually get around to understading leveraged ETFs, XIV and such. And I end the day with an awesome new addition to my list of RSS ;-)
MuffinFlavored 9y ago
why to hold overnight? look at what XIV did the past 18 months and compare it to SPY :)
Donald 9y ago
This wasn't overnight decay (plus this is short vol, so contango works for you.) This was panic selling as XIV neared its terminal drawdown point.
snthpy 9y ago
Nothing too mysterious in the examples in the SEC Alert link. One just has to keep in mind that these ETFs leverage the daily return and then take into account the compounding effects. If you have an index with normally distributed returns with mean m and volatility v, then the long term compound return c is c = m – 0.5 v^2 . An ETF which leverages k times will have returns with mean km and volatility kv. The ETFs long term compound return e will be e = (km) – 0.5 (kv)^2 = k m – k^2 0.5 v^2 = k (m – 0.5 v^2) – (k^2 – k) 0.5 v^2 = k c – k (k – 1) 0.5 v^2. For k > 1, the second term will always be negative so the ETFs return will always be less than the leveraged compound return of the underlying index. Whether the leveraged ETF return will be more or less than the underlying index return depends on whether c > (k – 1) 0.5 v^2 <=> m – 0.5 v^2 > (k – 1) 0.5 v^2 <=> m > k 0.5 v^2 <=> m / (0.5 v^2) > k. In other words, the leverage k has to be kept less than the m / (0.5 v^2) which is the well known Kelly Criterion.

tveita 9y ago

I don't know if this is a recent phenomenon or if I just haven't known where to look before, but after the stock fall I'm seeing links to remarkably unsophisticated "investors communities" of a kind I'd only seen for cryptocurrencies before. The description of these XIV derivatives just screams "run" to me, they're pretty much guaranteed to eventually drop to 0 if you hold them long term. Maybe they have some sort of hedging purpose in n-dimensional financial chess, but there's no way they should have been part of someone's personal portfolio. And yet I've heard multiple tales of people trading them, even on margin! I'm reservedly optimistic about trading platforms like Robinhood, but maybe in the end they'll turn out to be just another way to funnel dumb money into a bubble.

joezydeco 9y ago

XIV is dead. https://www.marketwatch.com/story/credit-suisse-announces-plan-to-liquidate-xiv-inverse-volatility-etn-2018-02-06 https://www.marketwatch.com/story/credit-suisse-announces-pl...

hcknwscommenter 9y ago

I just don't get it. Broken? The darn thing has done almost exactly what it was designed to do. VIX futures went up after hours, way up, and XIV went way down. That is how an inverse VIX futures product is supposed to work. I would buy some right now if they hadn't announced liquidation. People are acting like the ability of a product to go to zero, or close to it, should be a deal breaker, i.e., that such products should not exist. That is crazy. Individual common stocks go to zero (bankruptcy) all the time.