The VIX Can’t Cause Vol – Cboe’s View on Volatility ETPs

Spencer Doar

Spencer Doar

Associate Editor

As volatility began to surge in February, and then exploded on the fifth of the month, exchange traded products (ETPs) that shorted or provided inverse exposure to VIX futures came under fire.

The two most popular, Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term exchange traded note (ETN), ticker XIV, and ProShares’ VIX Short VIX Short-Term Futures exchange traded fund (ETF), ticker SVXY, were the main focus, as they suffered huge losses. Trading in them was halted and then Credit Suisse announced it would liquidate its note. Those two products, more than any other, put intense scrutiny on such volatility products and the Cboe’s VIX itself.

Cboe saw its own shares tumble from around $135 to $115 in the ensuing days’ trading, a fact attributed to the exchange’s connection with the instruments in question. Some big banks downgraded Cboe stock. On Wednesday, Cboe’s executives addressed the attention surrounding volatility with the aim of clearing up “misconceptions.”  

A key point made by Cboe executives was that these products all worked exactly as designed and trading at the Cboe was “orderly and liquid.” As has been pointed out, XIV explicitly stated in its prospectus that in the event of an 80 percent drop in value it could be liquidated. Meanwhile, SVXY is an ETF, not an ETN, making it a more transparent product. And it resumed trading and garnered more interest as the spike in volatility led investors to resume their short volatility trade.

In a conference call Wednesday, Cboe also addressed concerns that the plummeting funds would lead to a material decrease in the trading volumes of VIX futures. The assets in these funds before the selloff was some $2 billion, and each accounted for roughly 5 percent of trading VIX futures volumes per day as the funds rolled a portion of their futures positions to maintain consistent exposure. Executives said recent events would not affect volumes and pointed to increased attention on the VIX as a perfect moment to further educate and draw in new participants to the market.

Cboe Chairman and CEO Ed Tilly pointed out that the surge in VIX to more historical norms opens up a whole world of trading strategies that weren’t used when VIX was hovering at or around 10. Various strategies for playing the VIX futures curve are now alluring, for example. Plus, looking simply at declines in inverse products does not accurately reflect their effectiveness as a hedge.

Moreover, the recent focus was on inverse and short ETPs, which caused pain for some prop firms, wealth managers and retail traders, but the regular VIX ETPs witnessed large increases. They used to be the whipping boy as they consistently declined when VIX futures were in backwardation due to the cost to carry. But the VIX ETPs in aggregate weren’t all negatively affecting market participants.  

As for the regulators, Cboe President and Chief Operating Officer Chris Concannon believes they will look at disclosures and marketing of these products, but said he did not expect the scrutiny to alter the state of the volatility complex at Cboe itself.

The market will decide if these are satisfactory answers and whether the short volatility trade was a stone tossed in the trading pond that indeed rippled outward. Regardless, it’s a safe bet interest in the VIX and volatility trading will not suffer.

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