‘Short-volatility Armageddon’ craters a pair of Wall Street’s most popular trades, could roil market
Mark talks about the impact of a spike in volatility on XIV and VIX-centric funds.
One of the most popular trades in the market, betting a period of unnatural calm would continue, may have amplified selling pressure in the stock market on Monday market participants said.
At least two products tied to volatility bets were severely whacked with the hemorrhaging that could pose challenges to the exchange-traded notes.
One popular product, the VelocityShares Daily Inverse VIX Short Term ETNXIV, -7.48% was down 90% in after-hours trade on Monday, following a session in which the Dow Jones Industrial DJIA, +0.82% plunged by 1,175 points, or 4.6%, while the S&P 500 index SPX, +0.66% tumbled 4.1%—both benchmarks coughed up all of their gains for 2018.
The Cboe Volatility Index VIX, -17.38% meanwhile, skyrocketed by about 118%, marking its sharpest daily rise on record. The VIX uses bullish and bearish option bets on the S&P 500 to reflect expected volatility over the coming 30 days, and it typically rises as stocks fall.
The XIV, meanwhile, was designed to allow investors to bet against a rise in volatility and such bets had been a winning proposition until recently, when equities accelerated a multisession unraveling fueled by fears that the Federal Reserve will be forced to raise borrowing costs faster than anticipated due to a potential resurgence in inflation, which had pushed Treasury yields higher.
Monday’s stock-market drop may have been amplified because those making bets that volatility, as measured by the VIX, would remain relatively subdued, were caught wrong-footed.
“Moves in the VIX had XIV scrambling to cover,” said Mark Longo, CEO of Chicago-based research firm TheOptionsInsider.com.