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Background Shorting volatility proved to be very profitable historically. The reason is that VIX futures are drifting lower over time, so all you have to do is being short a product that is long volatility (like VXX) or being long an inverse product (like SVXY). Looking at VXX historical chart tells the whole story: So what's the catch? Well, the issue with going short VXX (or being long SVXY) is those occasional big spikes, like the one in 2008. So the trick is to find a strategy that goes short VXX or long SVXY, but at the same time, doesn't lose much during those occasional spikes. This article tells the story of an incredible SVXY trade that was a big winner despite the total collapse of SVXY. Few months ago, SteadyOptions introduced a new strategy called PureVolatility. The portfolio is managed by our veteran member and mentor, Scott Batchelar. Here is an extract from the strategy introduction: Strategy Description We will be looking to hold constant exposure to short volatility while the curve is in significant Contango in an effort to harvest volatility premium. We will also look to go long volatility when the curve is in significant Backwardation and indicators reveal the trend will continue in the short term. Because the curve is in Contango approximately 80% of the time, we will hold short exposure to volatility most of the time. The main strategy to gain this exposure will be through a Collar spread. The PureVolatility model portfolio will be based on total capital amount of $10,000 with a 5% allocation on risk. This is very important as those who are trading in a Reg-T account would on average need $10,000 in initial margin to hold the position even though the risk may only be $500. Portfolio Margin accounts would only require the $500 max loss amount. Reg-T is somewhat antiquated when it comes to margin for a Collar spread. However, this really should not be an issue because if one does not have $10,000 to put aside for this strategy it is probably not appropriate. Furthermore, the increased margin amount will keep members from over allocating to this very aggressive strategy. We will target a risk reward of better than 1:1 for a two week holding period. Here is an example of the Hedged Collar strategy sized for the model portfolio: 100 shares of SVXY at 101.93 Short 1 contract of the 11/10 110 Call at (1.35) Long 1 contract of the 11/10 103 Put at 5.54 Using the above example, here is the P/L chart of the trade: Please note that the profit potential is around $400 and risk around $300. For a strategy that wins around 80% of the time, this is an incredible risk/reward. But it gets even better. One of our other veteran members posted the following comment on the forum: After some discussion, it has been decided to modify the trade and use deep ITM calls instead of the shares. Here is an SVXY "modified" collar entered on January 30 with SVXY at 114: P/L chart: Please notice how using ITM calls instead of shares allows to reduce the risk if the stock makes a big down move. The next day SVXY moved higher and short call has been added. On February 2 SVXY started to move down. By the end of the day on February 5, SVXY went down around 40%. After few adjustments the P/L chart looked like this: The trade was down $750 or 7.5% loss on $10,000. This is completely reasonable, considering that the underlying was down 40%. Any bounce to $90 area should bring the trade back to breakeven. But then black Tuesday came. SVXY opened around $11, 60% down. The calls became nearly worthless, but the puts were the big winners, far outpacing the losses in the calls: Overall this trade produced almost 45% gain on margin or 26% gain on $10,000 portfolio. The bottom line: A trade that was long SVXY, was a big winner after SVXY went down 90%+. This is options trading at its best. And this is the power of our trading community. Read the full description of the PureVolatility strategy here. Related articles: The Astonishing Story Behind XIV Collapse The Incredible Option Trade In VXX The Lessons From The XIV Collapse The Spectacular Fall Of LJM Preservation And Growth

Unfortunately, there is a serious lack of understanding of these products by the general public. SVXY is one such ETF, so today I’ll look at what it is, how it works and how it is priced. WHAT IS SVXY? SVXY is an ETF called ProShares Short VIX Short-Term Futures ETF. As traders can’t directly buy or sell the VIX index, numerous exchange traded products have been developed since the financial crisis as a way to hedge market volatility. Some, such as VXX have been “on a hell ride to zero”. SVXY has not had the same issue, but is has suffered dramatic falls during time of market volatility. As the name suggests (Short VIX), this ETF is short volatility, so will generally gain in value when volatility falls and drop when volatility rises. In the below chart, you can see that SVXY has generally been grinding higher during the bull market, but has experienced some precipitous falls at times. SVXY started trading on October 3rd, 2011 at a price around $10. With the ETF currently at $97.88, the ETF has had an 879% gain since inception. Even though the ETF is up big, it has experienced some big drops, such as -42% in 3 days in August 2015. HOW DOES SVXY TRADE? SVXY trades just like a stock, it can be bought, sold and even short sold whenever the market is open including pre-market and after-market trading periods. Average daily volume is currently 4.5 million and the average bid / ask spread is around 0.05%, so it is very liquid. Image Credit: ETF.com SVXY has options available to be traded with a wide array of strikes. Option spreads are similar to what you would find in RUT, maybe a little wider. HOW DOES SVXY WORK? (PRICING), WHAT DOES IT TRACK The value of SVXY is designed to return the inverse of the daily return of the most popular volatility ETF – VXX. VXX started trading on January 30th, 2009. On a split adjusted basis, it has fallen from 26,763 to 23.82 for a return of -99.91%. Taking the most recent trading day as an example (December 26th, 2016), VXX was -1.57% and SVXY was -1.35%. So, the relationship isn’t perfect due to the nature of the products and also the expense ratios. VXX has an expense ratio of 0.89% and SVXY’s is 0.95%. To understand how the price of SVXY will move, it is essential to understand how VXX is priced. I wrote a little about that here. This article on Seeking Alpha also explains it well: Therefore, as a general rule, VXX is going to decay over time and SVXY is going to rise. However, traders should not automatically assume going long SVXY and / or short VXX is a guaranteed way to make money. Sure, that trade has worked for the last few years, during a bull market, but it has experience sharp declines. The trade would also get hammered in a bear market. The reality is, if a trader was long SVXY and it dropped 75%, would they be able to continue to hold it assuming that it would to go over the long run? Maybe if you had $500 invested in it. But, what if you had $50,000 invested in it? SVXY HISTORICAL DATA AND PRICING MODEL When researching for this article I found a great spreadsheet that contains historical data for the maybe volatility products (VXX, VIXY, XIV, SVXY, UVXY, TVIX). Download the Spreadsheet The following chart also shows the performance of SVXY since inception, but also the backdated performance based on model data. Image Credit: Six Figure Investing You can see that during the financial crisis, SVXY dropped 92.5%. So simply going long SVXY is not a valid investment strategy. LONG SVXY OR SHORT VXX? Trading long SVXY or short VXX has the same underlying thesis. The trader is betting on a fall in volatility. SVXY can only go to $0. VXX can theoretically go to infinity. Profits can be made more quickly in VXX which is perhaps why some traders prefer it. In terms of risk, it is more prudent to go long SVXY rather than short VXX, but both trades can suffer potentially devastating drawdowns. Here is a great quote from Vance Harwood – “It’s interesting that an investment structurally a winner albeit with occasional setbacks is not as popular as a fund like VXX that’s structurally a loser, but holds out the promise of an occasional big win. It seems that people would rather bet on a correction, rather than the slow grind of contango.” Seems like the casino mentality is alive and well in the stock market where traders are aiming for that big win, but are generally disappointed. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. He likes to focus on short volatility strategies. Gavin has written 5 books on options trading, 3 of which were bestsellers. He launched Options Trading IQ in 2010 to teach people how to trade options and eliminate all the Bullsh*t that’s out there. You can follow Gavin on Twitter. The original article can be found here.