As many die-hard VIX sellers already know, it is very possible to make money with short VIX positions without any significant movement at all in the VIX. In this article, we will briefly explain the factors that go into this. If you have not read Greg King's previous article on shorting VIX, we would recommend you do so before reading this one.
Taking the period of time since January 3, the first trading day of 2017 to March 16, (the day of this writing), we see this phenomenon at work. During that time, the VIX index moved from 12.85 to 11.21 while hitting a high of 12.85 and a low of 10.58 during the period. Overall, the net move was -12.76% and the distance between the low and the high as measured from the starting level of VIX for the period was 18.1%.
So even if someone picked the high to short VIX and the low to buy it back, timing the market perfectly, the maximum return would have been +18.1%. Now keep in mind VIX is uninvestable as is, and that does not factor in transaction costs.
However, during that same time frame, a hypothetical static short position in continuously rolling VIX futures, as represented by the S&P 500 VIX Short-Term Futures Index would have gained a staggering +31.99%.
Moreover, a daily compounding position in shorter duration VIX futures contracts, as represented by the returns on the net asset value of the REX VolMAXX Short VIX Weekly Futures Strategy ETF (NYSEMKT:VMIN), would have gained 47.47% over this same time frame (note: past performance is certainly no guarantee of future results, with respect to the VIX, VIX futures, or VMIN). Still how is it possible that short VIX futures positions have risen more than the level of the VIX has fallen? Spoiler Alert: The answer lies in the steepness of the VIX futures curve.
Let's remember that a short position in futures of any kind has three potential sources of return. First, is the most boring. Collateral yield. Futures are leverage instruments, and so the cash collateral supporting them must have a yield to it. Ten years ago, this made a lot more of a difference than it does today because rates were higher, but it still counts for something.
A second source of return is the movements in the underlying index itself (in this case VIX). How the VIX moves up and down affects the corresponding prices of the VIX futures. And even though it may seem like a foregone conclusion that up movements in the VIX equate to up movements in the VIX futures, that may not always be the case, although most of the time it is.
Which leads us to our third source of returns, roll yield. This last source is what tends to confuse investors the most. Holding a position for a time period longer than the duration of the underlying futures contract means the position must be rolled. For example, before April expiry, an April VIX contract that has been sold short must be bought back and the May VIX contract sold in order to maintain the short position. Through this contract swapping process, a profit or loss is achieved.
The above graph shows the VIX futures curve as of the close on March 16, 2017; we can see that the March, April, and May prices are 11.93, 13.28, and 14.33 respectively. Let's assume the curve were to stay the same shape over time and that the level of the VIX does not move.
If we assume the April contract (now at 13.28) follows the curve down, and in a month, closes where the March futures contract is now (at 11.93), that short position would increase by the difference (1.35 or around 10.17% on the shorted notional). The punch line here is that, given our assumptions, spot VIX has not moved but value of the short VIX futures position would have increased by 10.17% in one month.
This is the secret appeal to shorting VIX. The steepness of the curve lately has rewarded short position holders handsomely, even though VIX has not moved much. Although they are bearing the risk of VIX rallying unexpectedly (a significant one), many still choose to employ this strategy. And now you know why.
- The market price return for VMIN is 47.26% for the same period. NAV return for VMIN from inception (5/2/16) to 12/31/2016 was 81.24%, and the market price return for VMIN was 81.08% for the same period. The fund's expense ratio is 1.45%. Past performance does not guarantee future results. Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Short-term performance is not a good indication of the fund's future performance, and an investment should not be made based solely on returns. Shares are bought and sold at market prices and not individually redeemed from the fund. Brokerage commissions will reduce returns. NAV is calculated using prices as of 4:15 PM Eastern Time. The market price is the Mid-Point between the Bid and the Ask price as of the close of the exchange. Market price returns do not represent the returns an investor would receive if shares were traded at other times.
REX Shares, LLC ("REX") creates intelligently engineered alternatives ETFs that seek to help investors navigate turbulent markets and preserve wealth. REX was founded with a focus on gold and volatility based investment strategies. REX is based in Westport, CT.
Rex Shares Funds are distributed by SEI Investments Distribution Co. (One Freedom Valley Dr., Oaks, PA, 19456), which is not affiliated with Exchange Traded Concepts, LLC or any of its affiliates.
Carefully consider the Funds' investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Funds' prospectus, which may be obtained at www.rexetf.com. Read the prospectus carefully before investing.
Investing involves risk, including the possible loss of principal. VMIN is actively managed. Active management may increase transaction costs. The VIX Index is not directly investable. VMIN expects to invest primarily in VIX futures contracts, which are considered commodities.
The use of derivatives, such as futures contracts, swap agreements and options, presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Changes in the value of a derivative may not correlate perfectly with the underlying security, asset, rate or index. Gains or losses in a derivative may be magniﬁed and may be much greater than the derivative's original cost. The derivatives may not always be liquid. This could have a negative effect on the Funds' ability to achieve its investment objective and may result in losses.
Short positions lose value as the security's price increases. The loss on a short sale is theoretically unlimited. Short sales involve leverage because the Fund borrows securities and then sells them, effectively leveraging its assets.
The return for VMIN for periods other than a full trading day will differ from VMIN's stated daily inverse investment objective. During periods of high volatility, VMIN may not perform as expected and may have losses when an investor may have expected gains if VMIN is held for a period that is different than one trading day.
ETF shares are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. NAVs are calculated using prices as of 4:00 PM Eastern Time. The closing price is the Mid-Point between the Bid and Ask price as of the close of exchange.
The CBOE Volatility Index (the "VIX") is a product of S&P Dow Jones Indices LLC ("SPDJI") and is based on the CBOE VIX methodology, which is the property of Chicago Board Options Exchange ("CBOE"), and has been licensed for use by REX Shares, LLC ("Licensee"), the sponsor of the REX VolMAXX™ Long VIX Weekly Futures Strategy ETF and REX VolMAXX™ Short VIX Weekly Futures Strategy ETF. S&P® is a registered trademark of Standard & Poor's Financial Services LLC ("S&P"); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"); CBOE® and VIX® are registered trademarks of the CBOE. The CBOE VIX methodology and the trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Licensee. The REX VolMAXX™ Long VIX Weekly Futures Strategy ETF and REX VolMAXX™ Short VIX Weekly Futures Strategy ETF are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, or CBOE and none of such parties make any representation regarding the advisability of investing in such products nor do they have any liability for any errors, omissions, or interruptions of the Index.
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