SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

The Astonishing Story Behind XIV Debacle


During the market's closing hour on Monday, February 5th, some sort of "flash crash," likely triggered by margin calls, attacked the CBOE Volatility Index (INDEXCBOE:VIX), also known as the "fear index." What was a bad day, turned into a never before seen move. Here is it: 

VIX2718.png

 

Whatever it was, the VIX went from 17% to 37% in a matter of two-hours, or up 115%. That is the largest percentage gain in the VIX in one day ever recorded. 


Even then, while that is a huge move, it wasn't really market disruptive in any great way other than, the market had a bad day. But then the after hours margin calls came in -- and that was an unmitigated disaster for one particular instrument of interest to us: Credit Suisse AG - VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ:XIV). 

DON'T LISTEN TO TV 
The reporters on television have no understanding what XIV is -- it is not a naked short bet on VIX. No, it is an investment in the core underlying principle of market structures, driven by positive interest rates, known as Contango. 

Remember, the XIV is the opposite of VXX, and the expected value of VXX is zero. Here it is, from the actual VXX prospectus: 
 

vxxzero.jpg


This instrument is not a radical short trade, it is fundamentally an investment in an ETN that reverses the value of an investment that is ultimately expected to be zero, which made it so good, for so long, and would have for several more decades. 

WHEN A LINE BECOMES THE FOCUS 
A little detail in the prospectus of XIV is that, hypothetically, should it lose 80% of its value from the close, it would cause a "acceleration event." That means that if the XIV sunk to 20% of its value, it would go to zero and the ETN would go away (and start over later). 

Now, obviously, this had never happened to XIV before, but it's only a decade old. When scientists back-tested XIV all the way back to the 1987 crash and including the 9/11 terror attacks, they noted that even then, XIV would not have suffered a 80% decline in a day. But we have never seen such a market with so many naked short vol sellers as we have today. 

As a barometer, even as crazed as Monday was, here is how XIV closed: 

XIVclose2718.png


Down 14.32% is ugly, but, it's just a day -- a bad one, but nothing really all that crazed. Then the after hours session happened, and the best anyone can tell, as of this writing, is that some firm (or fund) had to unwind a short volatility position due to a margin call. 

That meant they had to buy the front month expiration of the VIX futures, leaving the second month unchanged. That little detail is everything, because the XIV is an investment on contango -- when the second month is priced higher than the first month. This is a market structure apparatus -- we could call it "normal market structure." 

But, with a flood of buying to cover short front month futures, the XIV started tumbling after hours. At first, social media saw it as a buying opportunity. Then it started dropping faster. Then disaster struck. 

The XIV dropped more then 80%: 

XIVah2718.png


The financial press did its best to cover it, but after a 2 minute segment on CNBC, there was nothing left to say because of one major rule inside the XIV prospectus. Here it is: 
 

xivacc.png


In that fine print, it reads that if the value of XIV dips to 20% of the closing value (if it is down 80%), the fund stops. That is, since this trade, if done with actual futures contracts, can actually go negative, the ETN stops itself out at a 80% one day loss. This is why we investors use the ETN, knowing that a 100% loss is the worst that can happen, as opposed to the futures, where much worse than 100% loss can occur. 

And the greatest burn of it all 
As of Tuesday morning the VIX is down huge (of course it is), the market structure has held (of course it did), and XIV would be having a very good day (of course it would). 

But, worse --- it turns out, as far as we know (still speculation), while it's hard to swallow, that the unwinding was done by none other than Credit Suisse itself. Yes, the creators of the ETN had another concern, beyond the assets under management -- and here it is -- -- look at the largest shareholder
 

xivholders.jpg

Credit Suisse quietly became the single largest holder of the very instrument it created, and by a huge amount. So, as 4pm EST came around, a bad day in XIV, but survivable, became the death knell, because the largest holder, the XIV's custodian, panicked, and covered. 

But, Credit Suisse could not very well just sell millions of shares of XIV in a thinly traded after hours session, so it turned to the VIX futures market. 

It appears, as of this writing, that this has actually occurred. While Credit Suisse (the issuer of the ETN) has yet to comment, it appears that whatever this "flash crash" did, whatever margin calls were triggered after hours, the short vol trader was in fact the firm -- it unwound positions in a size that the market has never seen before, and that means that it looks like XIV is possibly going to some very, very low number -- like $0, low. 

It's with great regret that as of right now, we do believe XIV is, for all intents and purposes, gone, from a little rule hidden deep in the prospectus that no one gave much concern and that got blasted away when the top holder in the note was the custodian itself. 

It's a reminder that the real danger to a portfolio is not a bear market -- we recover from those quite nicely as a nation -- it's the delirium that happens when a bull market gets totally out of control and margin is used excessively in a spurt of just a few days. And by margin, we don't mean normal, everyday investors, we mean the institutions -- even the ones we entrust to be custodians of our investments. 

So that's it. XIV likely would have done just fine after this moment in time in the market, will not be given that opportunity to recover. It has been blown out on the heels of yet another Wall Street debacle, which no one seems to even understand, yet. 

The author is long shares of XIV in a family trust. 

Ophir Gottlieb is the CEO & Co-founder of Capital Market Laboratories. He contributes to Yahoo! Finance, CNNMoney, MarketWatch, Business Insider, and Reuters. This article was originally published here.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 242 views
  • Lumpy Dividends and Options

    Dividend payments, like oatmeal, may be smooth or lumpy. Smooth dividends are predictable, usually once per quarter. It is easy for options traders to believe these dividends are guaranteed, because they usually continue uninterrupted quarter after quarter. This also makes it easy to predict total return over a longer time span.

    By Michael C. Thomsett,

    • 0 comments
    • 268 views
  • Coming to Peace With Market Volatility: Part II

    On April 18th I wrote part I of this article, Coming to Peace With Market Volatility. I showed how the US equity market risk premium, defined as the annual average return of the Total Market minus the return of one-month US Treasury Bills, was a large 8.37% per year from 1950-2019. That’s the good news.

    By Jesse,

    • 0 comments
    • 250 views
  • Ratio Calendar Spreads

    The ratio calendar spread is well-known to some, but for others the risk/reward aspects are not well understood. One way to cover a short position is to own 100 shares of the underlying stock. Another, more creative way is to sell a shorter-term expiration position and buy a longer-term position.

    By Michael C. Thomsett,

    • 0 comments
    • 612 views
  • Studies Vs. Real Trading

    "Who you gonna believe, me or your lying eyes?" Our members and readers know that buying pre earnings straddles has been one of our favorite strategies that produced consistent gains in the last 8 years with very low risk. Yet there is a significant number of studies showing that this strategy has a negative expectation. 

    By Kim,

    • 0 comments
    • 646 views
  • Should You Hedge or Diversify?

    Using the most popular S&P 500 ETF (SPY) to represent the US stock market, this article will look at different ways to manage equity market risk using historical ETF and options data from ORATS Wheel since 2007. We will analyze the following unhedged, hedged and allocation choices:

    By Jesse,

    • 11 comments
    • 945 views
  • Coming to Peace With Market Volatility

    From 1950-2019, the average annual US equity market premium (return of the total stock market minus the return of one-month US Treasury Bills) was 8.37% per year. This was a large average annual risk premium for owning stocks.  The premium was volatile, with a Standard Deviation of approximately 15% per year.

    By Jesse,

    • 0 comments
    • 448 views
  • 1,300% Gain in One Day? Not so Fast

    Would you like to book a $1,300% gain on a one day low risk trade? I would. That would imply that you turned your $100,000 account into $1,400,000 in just one day. Do it couple times - and you are a billionaire. Sounds too good to be true? It is possible in a Twitterworld. In a real world.. not so much.

    By Kim,

    • 0 comments
    • 485 views
  • A More Diversified Anchor Strategy

    Over the past few months, the performance of the Leveraged Anchor strategy has exceeded our expectations.  There has also been a few things learned regarding adjustments after large market falls, that had never been contemplated (see Anchor Analysis And Options). 

    By cwelsh,

    • 0 comments
    • 471 views
  • Relative Yield of an Option

    What is the “relative yield” of an option? There is a tendency to think of yield in terms of dollar value in premium alone, but to not factor in other elements. This makes side-by-side comparisons invalid unless adjustments are made. Dollar value by itself ignores the true yield, not to mention moneyness and time aspects.

    By Michael C. Thomsett,

    • 0 comments
    • 452 views

  Report Article

We want to hear from you!


Over the long term, shorting volatility is still a winning strategy. The key is position sizing. Check out our performance - VXX and SVXY trades are still very positive, despite the last two losers. But we are doing reduced position sizing (5% instead of 10%) due to higher risk.

Share this comment


Link to comment
Share on other sites

But what’s troubling about Ophir’s article is that it’s not the market that determined the fate of XIV/SVXY but a single rogue player with huge monetary influence.  There’s no way to rationally play the odds in such an environment- is there? 

Share this comment


Link to comment
Share on other sites
4 hours ago, NikTam said:

But what’s troubling about Ophir’s article is that it’s not the market that determined the fate of XIV/SVXY but a single rogue player with huge monetary influence.  There’s no way to rationally play the odds in such an environment- is there? 

I think our SVXY collar proves that you can still make money if you know what you are doing.

Share this comment


Link to comment
Share on other sites


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido