U.S. stock volatility spikes; short volatility ETPs implode

Logo of Swiss bank Credit Suisse is seen in Winterthur

The logo of Swiss bank Credit Suisse is seen at a branch in Winterthur Switzerland

The XIV is down more than 82% after hours.

The gauge of US stocks volatility known as VIX, which tracks the volatility implied by options on the S&P 500, recorded its biggest one-day surge in more than two years as investors rushed to buy derivative products to protect against a further slide in stock prices.

One of the hottest trades in recent memory, shorting volatility, evaporated in a heartbeat Monday.

The CBOE Volatility Index, better known as the VIX, is the most widely followed barometer of expected near-term volatility for the S&P 500 Index. Janus Henderson Group plc, which markets the VelocityShares notes, could not be reached immediately.

Market watchers are pointing to an exchange-traded security called the XIV, which is structured to go up when the VIX falls.

Last year, traders argued that the VIX remained depressed because realized volatility in US equities has diminished and economic fundamentals remain supportive. And what that means is, in the long run, you won't get predictable results from these investments.

Dave Roberts, an independent trader of volatility products and associated derivatives, noted that at the expiry of the January VIX contract, the front and second-month contracts were trading at a fairly narrow spread, in contrast to the wider gap at the December expiry.

But even if you think market volatility will subside, the sudden sell-off exposed major risks to using these investments.

Credit Suisse stock was down 4% in afternoon trading.

Credit Suisse, which is the biggest holder in one of the products, is down more than 6% in after-market trading.


"While it's not the underlying cause", RBC Wealth Management portfolio analyst Kelly Bogdanova said, the volatility funds "certainly fueled the move and made it a bigger move".

Investors said the proliferation of short-term traders, some using computers to trigger trading decisions, had also exacerbated the price swings of the past few days. At the time of writing, the 14-day ADX for VIX Mid-Term Futures ETN Ipath (VXZ) is standing at 37.32.

The repercussions have been severe for some funds.

Credit Suisse's share price has recovered slightly following a statement to the effect that the bank's exposure to the XIV ETN was fully hedged and CS therefore won't be affected by any of the losses relating to it.

During the market implosion on Monday, you may have heard the word "volatility" quite a bit.

This was the first serious test for these ETFs, most of which were launched after the global financial crisis. The pick-up in stock market gyrations early last week drove more people to bet on subdued stock market gyrations, said Anand Omprakash, director of equity and derivative strategy at BNP Paribas in NY.

Roll-over rebalancing is related to the fact that the short-term volatility futures contracts expire on a daily basis. Simply put, the ATR determines the volatility of a security over a given period of time, or the tendency of the security to move one direction or another.

Cboe Chief Operating Officer Chris Concannon said it was likely that regulators would take a closer look at these products.

The VIX, however, is not an actual measurement of volatility.

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