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Quant analyst, FRM & CAIA chartholder
  • Backward Simulation For Volatility ETNs (2006-2011) 14 comments
    Jul 15, 2012 1:24 PM | about stocks: VXX, XIV, VXZ, TVIX

    One of volatility traders I met, dd2020dd, recently discuss about is there any volatility-drived ETN designed for holding in long-term ? This is also a question in my mind for a long time. It's said considering (1) credit risk, (2) market risk, (3) liquidity risk, (4) price tracking risk and (5) early redemption risk and compounding risk, any prudent investor should not hold those ETNs for more than 10 days. However, if you do want to take risk , what should you pick with best shot ?

    Below is the display of S&P 500 constant-maturity indices

    underlying four major ETNs: the VXX (Blue), VXZ (Green), XIV (Red) and TVIX (Light blue). You could find this chart in the paper "Understanding ETNs on VIX Futures " written by Carol Alexander and Dimitris Korovilas in ICMA Centre, Henley Business School at Reading and you can find here . These indices were first quoted in December 2005 (till Dec. 2011), starting at a value of 100,000. Interestingly no ETN issuers provide this chart inside the prospectus, if they did, retail investors should think twice before put money in.

    (click to enlarge)

    If we update the chart to 13th July, 2012, we could find XIV is the only vehicle with significant gain (around 68% gain) for holding 6.5 years, which significantly beat SP500 index performance for the same period of time. Not surprisingly, the contango effect does erode TVIX, VXX & VXZ most of time. While VXZ still log mild gain or loss (less than 10%) over 6 years, due to the huge jump during 2008 crisis.

    I can't agree more with the dd2020dd's conclusion: Although it's much like taking financial roller coaster, combined with contango over 80% of the time, makes an inverse volatility product like XIV the logical choice for a long term trading alternative and provide you the best shot in volatility universe. If you happen to time the market well, inverse volatility product might even provide some decent gain.

    Disclosure: I am long XIV.

    Themes: Volatility Stocks: VXX, XIV, VXZ, TVIX
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Comments (14)
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  • dd2020dd
    , contributor
    Comments (80) | Send Message
     
    Thanks for the historical simulation. It supports my conclusions. Will continue to monitor XIV holdings, reducing significantly if value drops 3%, 100% out at 5% drop. Will reenter as market conditions permit. Stll expect to realize 50% gain in 6 months, even after rising 30% in last 30 days
    16 Jul 2012, 07:21 PM Reply Like
  • hunterhsu08tw
    , contributor
    Comments (44) | Send Message
     
    Author’s reply » Let's see US Q2 GDP data and whether it could bring shock to the market.
    16 Jul 2012, 11:44 PM Reply Like
  • dd2020dd
    , contributor
    Comments (80) | Send Message
     
    reduced my position in XIV today. Uncertain of effect of expiring July futures with spot VIX at 16.48 and August at 18.55. Took a wait and see approach. Any insight?
    17 Jul 2012, 09:46 PM Reply Like
  • Arshok
    , contributor
    Comments (32) | Send Message
     
    I do not believe that the impact of a contract expiration is something to be concerned about. Going long XIV, it will be a favorable influence if anything. Where it has potential to be more significant is in a situation like we had last Fall, where there is a sustained level of fear, fear that things could turn get worse and south any day, yet without it actually happening. In this case, the spread between the spot vix and vix futures may expand. If nothing materializes, as a contract gets closer and closer to expiration, the contracts price will move more and more rapidly towards the spot vix. But, the impact of this movement will be less and less, as with each passing day XIV's exposure to the near-term contract is less and less. The nature ETN's composition is such that this isn't something to be overly concerned about.

     

    On the subject of the article:

     

    After last August, I will never, ever call XIV 'easy money'. In fact, i nicknamed it the widowmaker. (1) In a bull market, it will roar. I would love to see how it would have done in the 90's. (2) In the event of sustained panic, such as last fall, where we had MONTHS of sustained backwardation, it's 'value' erodes so fast you won't know what hit you.

     

    Therefore, it's logical to presume that in-between crashes, XIV will truly take off. The problem is in each crash, XIV will likely lose no less than 50% of it's value. This is about what it lost last year. You'll notice that it quickly 'bounced back' 100%, going from 4.75(ish) back to 10 with relative ease. That was the easy part, as Vix futures ticked down from 30 back to their natural range around 20. Everything from here needs to come from Contango. It will take months of contango to make up for what was lost to backwardation last fall.

     

    Consider this thought exercise. XIV goes up 300% to approx. $40 before the next crash. It then loses 50% of it's value, it's back to $20 (Probably went much lower before bouncing back to $20 as Vix futures returned to 20ish). It then goes up 300% again, between crashes, and makes it to $80. It crashes again, it's back to $40. Etc. etc. This is a possibility. It depends on the amount of time between crashes. In this scenario, XIV is an excellent mid-term investment. mid-term could mean 5, 10, or even 20 years. On a long enough timeline, there will be an incident that causes a crash that will wipe out 95%+ of XIV's value, in which case any gains made will almost certainly be lost. That may or may not happen in our lifetime, we have no way of knowing. The 2008 financial crises would not have been enough to do it, so that gives you an idea of the disaster that would need to occur for something like this to happen. That doesn't mean it won't eventually happen.

     

    The other scenario is this (where XIV is a bad long term investment). XIV goes from $10 to $20 between crashes. It loses 75% of it's value. It's now at $5. It goes up 100% again between crashes. It's now at $10. It then loses 75% of it's value, and is as $2.50. etc. etc.

     

    In either case, there are only 2 options for XIV: (1) Over the course of many years and many crashes, it will continue to tick up, sometimes quickly, sometimes slowly (2) Over the course of many years and many crashes, it will continue to tick down, usually quickly followed by slow and steady gains, which are lost + more each crash. The jury is still out as to which one of these will prove true.

     

    In order to trade this, you have to be able to take a 75% loss without panicking and closing your position AND/OR buy more. Hence, the widowmaker. You need balls of steel to trade it. Or, you need to never look at it once you buy it. PS - Never trade it on margin. Cash on hand only.
    25 Jul 2012, 04:12 PM Reply Like
  • Arshok
    , contributor
    Comments (32) | Send Message
     
    I was reading 2 XIV articles at once, and mixed information from the two of them into my response above. This was an accident. The "Easy money" I was referring to is in reference to the other article I was reading, titled "Easy Gains From XIV"
    25 Jul 2012, 05:05 PM Reply Like
  • hunterhsu08tw
    , contributor
    Comments (44) | Send Message
     
    Author’s reply » Arshok, I agree with you, anyone who would like to trade XIV would know as much as he/ she could know about this financial instrument. As the matter of fact, the chart I put here should be viewed with much attention and that's part of XIV participants' preparation work (I wish I had this chart before). Post-Leman Brother seems to be a rare case, although we had just been through and then 2011 summer US Treasury lost AAA rating (that never happened in history), the black swan seems appear more and more often.

     

    The XIV has a natural mechanism to counter "extreme tail risk", mainly because of the daily re-balance structure, I will plan to explain it in the future
    26 Jul 2012, 11:35 AM Reply Like
  • theta_long
    , contributor
    Comments (10) | Send Message
     
    Very good comment. I would add that the only truly disastrous scenario would be a 100%+ increase in VXX in one single day, in which case XIV would lose 100% of its value and would never recover. All money would be lost, and the ETN would need to be reissued and start over with fresh money.
    This is of course very unlikely to happen. A hypothetical scenario would be a huge disaster happening completely out of the blue, spot VIX going from 15 to 60 or so, front month futures going from 17-18 to mid 30's. The only time in the past that this would have happened in the crash of 1987.
    In that case of course there's nothing stopping you from entering the same position again (as if the drop would have been 99% and not 100%) either in the new issuance of the note (that would take some time of course) or via an outright short in VXX.
    28 Jul 2012, 06:25 AM Reply Like
  • hunterhsu08tw
    , contributor
    Comments (44) | Send Message
     
    Author’s reply » from (a) put call ratio moving average & (b) economic expectation trend, it seems seesaw might come but should not repeat late March performance.
    17 Jul 2012, 10:19 PM Reply Like
  • MarcJoli
    , contributor
    Comments (78) | Send Message
     
    hunter, how are you charting the put/call ratio? What index ticker are you using to track this?
    25 Jul 2012, 02:53 PM Reply Like
  • hunterhsu08tw
    , contributor
    Comments (44) | Send Message
     
    Author’s reply » Are you referring my another instablog ? the CPCE and CPCI index is what I track for put/call ratio (for ages), you could find some articles try to quantify the complacency with these 2 index.

     

    Nice to meet you
    26 Jul 2012, 11:38 AM Reply Like
  • theta_long
    , contributor
    Comments (10) | Send Message
     
    Does anyone have the raw data and if yes, can they post the same graph in a log instead of linear scale?
    28 Jul 2012, 06:26 AM Reply Like
  • mn32
    , contributor
    Comments (6) | Send Message
     
    If you open up the prospectus for VXX, you'll find a chart on page ps-3 giving the historical level of the underlying index beginning 2005.
    30 Jul 2012, 12:16 PM Reply Like
  • hunterhsu08tw
    , contributor
    Comments (44) | Send Message
     
    Author’s reply » thank you, but as I check that today, I have not found any charts on page ps-3, but I do find the charts on ps-24, which is great since I can use that to claiberate the database I had on hand. Your information is pretty stumning because I do read the prospectus of TVIX and find nothing.
    30 Jul 2012, 10:58 PM Reply Like
  • untrusting investor
    , contributor
    Comments (9933) | Send Message
     
    Good article and content.
    30 Jul 2012, 05:17 PM Reply Like
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