How UVXY And SVXY Would Have Reacted In 2008 And 2011

| About: ProShares Ultra (UVXY)


UVXY would have provided substantial gains during the spikes in volatility in 2008 and 2011.

Backwardation aided UVXY in both cases, particularly in 2008.

With current market conditions, timing a falling VIX is less risky and a better strategy.

This is a follow-up to a previous article I wrote, titled "Profiting From Short Term Spikes In Volatility Using ETFs." I encourage you to read over that article before diving into this one. It provides some important background information on terms we are going to use. You can view the article here. If you are familiar with VIX terminology, I would continue on reading.

In the first article, we went over how to profit from a spike in the VIX, focusing on the downside profit. Now, we will observe how some ETFs would perform from substantial spikes in the VIX, focusing on upside profit.

My two favorite VIX Futures ETFs are:

  • ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY) 2x Leverage
  • ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) 1x Leverage

It should be noted that these are not the only ETFs out there that track the VIX futures. If you prefer, these are some other ETFs that can be used with the same strategies we are going to discuss:

  1. iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX)
  2. VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ:XIV)
  3. VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ:TVIX)
  4. ProShares VIX Short-Term Futures ETF (NYSEARCA:VIXY)

Let's start by taking a look at how UVXY and SVXY have performed since inception.


I would have you look to the lower level chart for the clear continuous downward trend.


Here, we see a clear upward trend, 529.77% per the chart. Not a bad return over three years.

What do these two charts have in common? They both do not include data from prior to 2011. The inception of both UVXY and SVXY fell in October of 2011. It also brings up a good quote "Past performance is not always an indicator of future performance." I am not sure who said it first, but the quote is repeated often and is a good example of my research findings.

We are going to take a sampling of VIX futures from two different time periods to see how these ETFs would have reacted to them. I found a great spreadsheet that is available for viewing, here. The author also offers his spreadsheet for purchase. This spreadsheet includes the theoretical prices of UVXY, SVXY, TVIX, XIV, and VXX. The author frequently updates the spreadsheet with current VIX futures data. This only affects current data, not historical data, which we will be using for this article. The example prices of UVXY and SVXY contained on my charts could be different than what you are viewing on the spreadsheet because of this update. However, my data charts exactly follow the historical values on the spreadsheet at time of this publication. Every VIX futures value on the spreadsheet, during the time periods we are discussing, was checked for accuracy.

I am only focusing on UVXY and SVXY in this article. The findings correlate to what the actual results of the VIX futures ETFs would have been. However, the actual performance of UVXY and SVXY could vary some, due to the creation and destruction of shares and operational expenses of the fund. If an event similar to the two we are going to review occurred today, you should anticipate high volumes on all VIX futures ETFs and ETNs. High volumes, from past experience, can affect the performance of the underlying ETF or ETN.

Let's get started!

First Time Period: September 2, 2008 - December 23, 2008

We should all be familiar with the financial meltdown of 2008. If not, please research it separately before continuing on, or read about it here. During 2008, investors panicked from what was believed to be an imminent collapse of the banking and financial system. At the peak of the crisis, the U.S. Government and its various departments (the Federal Reserve, for example, debatably part of the government) stepped in to provide emergency funds, thus saving (or preventing the destruction of) several industries.

Looking at the charts below, you can see that prior to these events, on September, 2008, volatility was trading at an elevated but mostly normal range. The front month VIX futures were trading lower than the second month, meaning they were in contango. As the events progressed, the front month futures prices moved higher than the second month futures, meaning they were in backwardation. An explanation of both terms was included in the first article. Backwardation continued to escalate throughout the crisis, providing solid theoretical gains for UVXY. Rather than listing each daily price, I created an easy-to-read chart with theoretical values for UVXY and SVXY.

Here are the VIX futures from the time period we are analyzing.

Analyzing the chart, it is important to note that VIX futures went into backwardation on September 12, 2008. This chart also tracks the Spot VIX, which correlates to VIX futures, but does not directly follow it. For example on October 8, 2008, the Spot VIX was around 80, while the futures price was around 60. Theoretically, if you invested in UVXY or SVXY on September 2, 2008, and sold on December 1, 2008, these would be your results.

UVXY: 1079.42%

SVXY: -79.87% (I personally believe that high volume trading would have pushed this down further)

Second Time Period: July 1, 2011 - August 15, 2011

Here are the theoretical returns for UVXY and SVXY, assuming you purchased shares on July 1, 2011, and sold on August 8, 2011:

UVXY: 199.34%

SVXY: -51.06%

Since the inception of UVXY and SVXY, the VIX index (not futures) has never risen over 45 (rounded), and that was on the day of inception. The VIX index, over a period of three months after inception of UVXY and SVXY, dropped to 25, and within six months, was at 15. After that event, the VIX index has traded in a range from 11-26 (rounded).

Let's go back to the future, like Marty McFly. To the DeLorean! The chart below shows where VIX futures stand as of May 30, 2014.

Currently, we are in some serious contango. 11.21% for a 2x leverage ETF such as UVXY equals a 1% loss of value per trading day (typically 20 trading days per month, 11.21x2 = 22.42/20 = 1.12%).

How do we use the data in this series to make wise investment decisions?

Basics: The VIX is a reactive indicator, not a predictor of future performance in the market, as many pundits and noise makers would like you to believe. Do you know what a good predictor of market performance is? Economics!

Outlook: My outlook on the U.S. economy is neutral for the next year and neutral-to-negative beyond that, here's why. My two concerns are the consumer (including wage growth) and government spending/liabilities (to include state and local governments). Current retail sales have been lackluster, to say the least. Retailers are using the weather as an excuse, but forward guidance is not good either. CBS has a good piece on poor wage growth and retail sales here. If these two issues can be resolved, I think the economy has much more room to grow. In either case, I do not see the economy crashing or the world ending. At most, I see consolidation in the market until wage growth returns and consumers increase discretionary spending. The consumer continues to face pressure from rising costs, not yet including rising interest rates. Wages must begin rising to make up for this, or discretionary spending is going to take a hit.

Just because the debt ceiling isn't in the news doesn't mean it no longer exists. With elections coming up, politicians would like you to be as happy as possible with the government. Expect this to change after the midterms. Any reductions in government spending or increase in taxes on the middle or lower classes will significantly affect the economy. Case in point, look at Wal-Mart's (NYSE:WMT) struggle with decreasing food stamp payments, here. Fun fact: Wal-Mart employees are the largest food stamp recipients in some states.

The current national deficit and growing liabilities make me very uncomfortable. What happens when interest expenses start to rise? The Federal Reserve only has so many tools to combat slow growth and hold down rates (almost all of them have been used or are currently being used, with some finally being wound down). Our current budget deficit and balance sheet looks like J.C. Penny's (NYSE:JCP). Everyone seems satisfied that results aren't as bad as they could have been. That still doesn't make up for the fact they're bad. Washington does not seem to be in a hurry to offer or work on solutions to these tough problems/choices ahead. Over the past two years, a majority of volatility spikes have come from government-created crises. Look for this to continue if elections result in a highly divisive congress.

Note: We are not here to debate the merits of government programs or talk politics. Regardless of political affiliation you should view the cards at hand, not what cards you would like to have. The emotions of politics do not belong in your investment portfolio. The effects of politics do.

Advice: The economic outlook is not yet bad enough to invest directly into UVXY. I would highly advise against it due to the current level of contango. Volatility spikes are hard to time on the upside and luck is not an investing strategy. I would recommend referring back to the first article and follow the downside strategy after volatility has peaked or is in decline. Investing in SVXY after a short-term pull back is still a good strategy assuming the economy is on firm ground, just understand your downside risks (and that it is a trade, not a long term investment).

Keep an eye on wage/job growth, the consumer, and mid-term elections. These areas will provide direction for the economy in the next few years.

Final note: I appreciate your comments and messages and will respond to most of them. One comment that stuck out to me was, "So, uh, does your crystal ball tell you what to do ex ante, or only ex post?" By day, I teach U.S. History, Civics, and Economics. My favorite question is, "Mr. Buehler, why do we have to learn about history?" History provides an important part of the story for analysis of current and future events. Economics is the true long term driving force behind the VIX. It is up to you to analyze current economic conditions and market trends to predict moves in the VIX. Each move in the VIX is like a fingerprint, unique and caused by different events. I can't tell you when the VIX will rise or fall suddenly. I can provide guidance, research, and data (current and historical) followed by my analysis and a recommendation.

At the end of the day it is your money. How hard are you willing to work to protect it? Relying on pundits and noise makers for quick investing ideas will end poorly for your brokerage account, unless you take the time to research, test, and validate what they are saying is true. If those are the ideas you are looking for, I am not the contributor for you. This series on UVXY, SVXY, and other VIX futures ETFs and ETNs is meant to provide you with the proper history and insight to make wise future investment decisions when attractive opportunities arise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.