Hey Trader,
Almost nothing gets me more excited than volatility …
So this week’s Big Developments in the volatility exchange traded product (ETP) market certainly gave me some food for thought!
Two newcomers were released …
One that is not too unlike other products on the market …
And another that is almost the exact OPPOSITE of other products on the market!
However … both of these should have huge “Caution!” signs flashing above their charts …
Because when they’re good, they’re great …
But they can both go very bad, very fast.
If you’ve been here a while, this likely isn’t the first you’re hearing about VIX exchange traded products (ETPs) or even two specific VIX ETPs: 1x Short VIX Futures ETF Fund (Ticker: SVIX) and 2x Long VIX Futures ETF Fund (Ticker: UVIX), both of which just launched this week!
Before we take a deep dive into these two products, let’s take a minute to review exactly what the heck VIX ETPs are, and why they can be so profitable … or dangerous.
You Down With ETPs?
The most important thing to know about volatility ETPs is that they are based on VIX futures, not the VIX index itself.
Why is this so important?
Typically, VIX futures are trading above the VIX itself.
This is called “contango” and looks a little something like this …
In times of high volatility, the VIX futures curve will enter backwardation, where VIX futures are trading below spot VIX.
However, the majority of the time, VIX futures are in a contango formation.
Now, the front-month future must be equal to the VIX itself at the time of expiration.
Which means that most of the time, VIX futures are shedding value, especially as we get closer and closer to expiration.
This brings us back to VIX ETPs.
One of the more popular ETPs (until it was recently blown up by its issuer) is iPath S&P 500 VIX Short-Term Futures ETN (Ticker: VXX), which intends to replicate a VIX future with 30 days to expiration.
Since there isn’t one future consistently 30 days from expiration, VXX accomplishes this by holding front-month and second-month futures, and selling the front-month to buy the second month to maintain a steady 30-day exposure.
But wait a minute … if VXX is selling the front-month, and buying the second month while futures are in contango …
That means VXX is buying high and selling low!
Not exactly a recipe for success.
In fact, VXX and similar ETPs historically have almost unbelievably bad long-term performances.
Check out the 10+ year performance of ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY), which provides exposure to the same 30-day future as VXX, but with 1.5x leveraged exposure:
Split-adjusted, over its lifetime, UVXY has fallen from $2 billion to its current perch around $19.
Yikes!
These are NOT buy and hold products. I repeat, these are NOT buy and hold products!!!
But while these products do a terrible job providing value over time, intraday they do work as intended, by providing relatively accurate tracking of intraday volatility, so they’re great tools for VERY short-term vol trades.
I actually trade them quite often in my Volatility Edge program (and I’ll be trading the ones we’re about to talk about, too!).
Now, there’s also volatility products that provide short exposure to vol futures …
Essentially the inverse of ETPs like UVXY and VXX.
And if long exposure products like UVXY and VXX are constantly LOSING value …
Short exposure product should GAIN value over time, right?
Volmageddon, the Vol-pocalypse!
Let me tell you a little story about Volmageddon …
In 2018, the market was cruising along as usual …
Until suddenly, markets started to slide …
And the VIX popped 115% in a single day.
This wouldn’t have been a huge issue …
But for short vol products like VelocityShares Daily Inverse VIX Short-Term ETN (XIV), it quickly became a HUGE problem.
XIV and other inverse volatility products plunged by as much as 90%, and XIV’s value plunged from $1.9 billion to $63 million.
XIV was closed shortly after, leaving investors to swallow their sizable losses.
Short vol products haven’t been the same since …
Until now.
New Vol On The Block
This week, VelocityShares decided to introduce two new volatility products …
One long, and one short.
1x Short VIX Futures ETF Fund (Ticker: SVIX) and 2x Long VIX Futures ETF Fund (Ticker: UVIX) began trading on Wednesday, with SVIX providing short vol exposure, while UVIX provides 2x leveraged long exposure (similar to UVXY).
Allegedly, VelocityShares worked out some of the “kinks” that led to XIV's demise, so they feel just fine about issuing a short vol product that is nearly identical (though of course there are a few key differences).
The market was actually quite receptive to the pair, though UVIX definitely saw more action in the options pits than SVIX, though on a straight share basis, SVIX proved more popular.
Shares began trading on Wednesday, with options following on Thursday.
UVIX has averaged more than 258,000 shares trading per day, with Friday seeing trading volume of 273,915. At Friday’s close, UVIX was down 7.2% on the day to 15.65.
SVIX thus far as seen an average volume of 339,085, with Friday volume topping 424,000! And while UVIX fell on Friday, SVIX actually tacked on around 4.1%, closing at 14.61.
Now … in the pits, it seems UVIX has captured the most interest …
Currently, UVIX has an open interest of 1,175, with calls outnumbering puts 2.4-to-1.
While UVIX options saw some heavy trading during their first day of availability – with more than 1,500 contracts crossing the tape – Friday slowed a bit, with total volume of just 346.
The most popular contract so far is the April 16-strike call (583) … followed by the April 16-strike put (202).
SVIX, on the other hand, saw just 67 contracts traded during their first day, with a slightly-higher 74 contracts crossing the line on Friday.
Compared to UVIX, however, its open interest of 67 looks rather paltry …
And it’s top open interest contract, the September 15-strike puts, has only 25 contracts.
And while UVIX trades skew to the call-side, SVIX skews much more heavily to the put side, with 54 puts open to just 13 calls – that’s a 4.2-to-1 ratio!
Now, typically when options are first listed, the implied volatility (IV) is way too high.
This is market makers protecting themselves, since they can’t yet be sure how options and options traders are going to react.
However, when compared to similar ETPs, UVIX is actually already pretty fairly priced!
That means we don’t need to wait for the vol to melt out to start trading it.
So if it looks like we are heading for a vol pop … UVIX offers one of the best ways to take advantage (but remember … we’re talking trade durations of hours, or perhaps a single day at most!).
Or if you think vol is getting ready to plunge … SVIX certainly offers some interesting possibilities.
Like I said, I plan to trade these ETPs in my Volatility Edge program.
Or you can subscribe to my free VIX Edge newsletter for daily updates on all things VIX and vol.
Just remember, whatever you do, remember the problem of contango … and always manage your timeframe and exposure to any of these vol products!
They can be hugely profitable … but also hugely dangerous.
Trader beware …
But have fun out there!
Your Only Option,
Mark Sebastian