The unprecedented surge in short-term volatility in the last couple of days led to a free-fall in products that bet against volatility on the view that volatility would stay low.
This is especially true as the CBOE Volatility Index (VIX), also known as the fear gauge, soared 115.6% on Monday, its biggest one-day jump on record, and then hit 50 for first time since 2015 on Tuesday before retreating to 30 at the close. The fear gauge measures investors’ perception of the market’s risks and tends to rise when a stock falls or investor panic starts to set in (read: Inverse Equity ETFs to Bet on Historic Selloff).
As a result, the two popular inverse volatility products VelocityShares Inverse Vix Short-Term ETN and ProShares Short VIX Short-Term Futures ETF (SVXY - Free Report) tumbled 92.6% and 83%, respectively, in a single day on Tuesday’s trading session. While XIV potentially triggered an acceleration event (closure clause) according to its prospectus, trading in SVXY halted for some time. Together these products had a combined $4.1 billion in AUM before the carnage, per etf.com.
Inside The Products
Both inverse volatility ETPs offer inverse exposure to the S&P 500 VIX Short-Term Futures Index, which provides exposure to a daily rolling long position in the first and second months of VIX futures contracts. The index reflects implied volatility of the S&P 500 Index at various points along the volatility forward curve.
Although both have similar objectives, XIV being an ETN, is exposed to the creditworthiness of the issuer. This is because the ETNs do not actually hold any securities, instead they are simply debt issued by banks that promise to pay to investors the amount reflected by the index’s performance (minus fees).
Further, since ETNs are debt, they have a maturity date — usually about 30 years after the issuing date — when the note’s principal is then paid out to investors. Some ETNs can also be called in by their issuer before the maturity date. This is what exactly has happened in the case of XIV (read: ETFs Vs. ETNs: What Investors Need to Know).
Per the VelocityShares prospectus, the company can elect to "accelerate" any of their ETNs, liquidating them early. "If the price of the underlying futures contracts increases by more than 80% 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% of the prior day's Closing Indicative Value and will be subject to acceleration. If an Acceleration Event occurs at any time with respect to any series of the ETNs, Credit Suisse has the right to accelerate all of the outstanding ETNs of such series."
Since the intraday indicative value of XIV on Feb 5 was equal to or less than 20% of the prior day’s closing indicative value, an acceleration event has occurred. Thus, Credit Suisse will liquidate trading of XIV on Feb 21. The last day of trading for XIV is expected to be Feb 20. As of the date hereof, Credit Suisse will no longer issue new units of XIV ETN (see: all the Inverse Volatility ETFs here).
Investors can either sell the ETN on the open market before the suspension, or wait for Credit Suisse to redeem the notes. In case of any wait, investors will receive a cash payment per ETN in an amount equal to the closing indicative value of XIV on the accelerated valuation date, which is Feb 15. The payment will occur three business days later on Feb 21.
Meanwhile, ProShares will continue to operate SVXY, which is structured as an ETF.
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