The Short Volatility Trade Sees Its Black Swan Event

by: Elusive Value

On February 5, 2018, the S&P 500 index saw a -4.1% change, which in itself is not extreme, although it is rare for the current bull market.

However, as traders loaded up on protective puts on the S&P 500 (SPX), the VIX cash (spot) spiked over 100%, causing the VIX term structure to go into extreme backwardation.

Popular short volatility ETFs like SVXY and XIV saw double-digit normal trading losses as VIX futures rose higher in response to the spike in VIX spot.

However, the big story is what happened after hours.

First off, condolences to anyone who may have been long the ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY), VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ:XIV), or the newer and lesser known REX VolMAXX Inverse VIX Weekly Futures Strategy ETF (NYSEMKT:VMIN). Investing is risky business, but if one is well diversified and does not trade on margin, an event like this should not cause a wipe out. Unfortunately, as with bitcoin and other frothy manias, it usually does not end well for those who go "all-in".

As a contrarian, I've been on the opposite side of the table for the better part of 3 years now. I'm not a perma-bear. But the last time I was really excited about buying stocks was back in late 2008, early 2009. It was very frustrating to see the market continually go up, shrugging off events like Brexit, even accelerating faster following the November 2016 election. It almost got to the point where I was seriously starting to doubt my strategy, with feelings of FOMO creeping into my thoughts. But thanks to prolific SA authors like The Heisenberg and Eric Parnell, calm thoughts prevailed and I stayed the course.

I was working on another article about the bear vs. bull case after January's market performance and some option strategies I put together, but then this happened:

(source: TD Ameritrade VIX.X quote)

As a refresher, the VIX cash or spot price isn't derived from buying and selling of the VIX or even of VIX futures. The VIX price is calculated at frequent intervals during the trading day based on a sampling of option prices of the S&P 500 index. There was very little demand for S&P 500 put options after the Brexit event, and rightly so. Realized volatility on the S&P had been well under 10% for the better part of 2016 and 2017. Implied volatility went the same way, meaning the VIX calculation was below $11 most trading days. We even saw some extreme low closes below $9. That caused the VIX "term structure" to look like this on January 3, 2018 when VIX closed around $9.15:


As long as the term structure looked like the above, particularly for the first two points on the graph (front and second month futures), SVXY and XIV would profit from the differential, or contango. This is why SVXY and XIV were such strong performers, making it to the top 5 best-performing ETFs of the past few years. They didn't have to worry about revenue beats, EPS, or losing margin to competitors. They simply had to buy and sell option contracts daily according to inflows and outflows.

And the fact that this rebalancing happens on a daily basis is important to understand as to what happened on February 5, 2018, when the VIX spot went over 100% to $37. The futures curve moved in response:


What the spike in VIX futures prices means for SVXY

What this means for the traders or computers who manage the ETF/ETN's holdings, is they need to rebalance contracts they held as of Friday, February 2. Let's take SVXY for example - that information can be found at

The following are the holdings in SVXY's portfolio as of market close, Friday 2/2/18. These represent the value of the front and second month futures contracts of CBOE's VIX index.


Exposure Value
(Notional + G/L)

Market Value ($)



Author's note

CBOE VIX FUTURE 02/14/2018 (UXG8) (679,968,750.00) - (43,518.00) This comes out to ($15,625) per contract, which matches 2/2 Feb 2018 quoted option price of $15.625.
CBOE VIX FUTURE 03/21/2018 (UXH8) (1,215,161,350.00) - (81,146.00) ($14,975) per contract - to 2/2/18 Mar 2018 quoted option price of $14.975
NET OTHER ASSETS / CASH - $1,893,132,269.00 1,893,132,269.00

See the problem? They're short 43,518 contracts of the Feb 2018 VIX, and 81,146 of the Mar 2018 VIX. We can kind of guess what the February 5th table will look like - these are estimates only - the price and number of contracts will definitely vary because of fund redemptions and intra-day option prices. So as of 2/2/18, Feb 2018 expiration closed around $15.625 and Mar 2018 closed around $14.975, vs. $29.20 and $24.90, respectively as of 2/5/18.


Exposure Value
(Notional + G/L)

Market Value ($)


CBOE VIX FUTURE 02/14/2018 (UXG8) (1,270,725.00) - (43,518.00)
CBOE VIX FUTURE 03/21/2018 (UXH8) (2,020,535.00) - (81,146.00)

That's big - almost a $1.4B difference in one day. Prior SA articles have discussed termination or liquidation events, whereby a daily change over 80% could result in the funds liquidating assets. This appears to be what's happening after hours. VIX was a hot topic on CNBC, and the discussion around these ETF/ETNs possibly going into a termination event could have sparked a panic. Brokerage firms may have been closing trades for margin buyers, or holders sold to try to recoup something. I didn't go through the same exercise for XIV, but it will be a similar situation.

Below is a screenshot of my SVXY and XIV short positions after hours. These were hard to borrow over the past year, and the gains are offset by losses from months of expired worthless VIX, ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY), iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX), and ProShares VIX Short-Term Futures ETF (NYSEARCA:VIXY) call options, not to mention the worst, which were naked short calls on SVXY that I had to buy back early to meet maintenance requirements when SVXY ripped higher.

(source: author's TD Ameritrade account)

Were there any early warning signs?

In a word, yes, but the warning signs were not what I previously thought.

I had a theory that a huge VIX spike could be predicted by an unusually high SKEW index reading. But as I watched it for the better part of a year, seeing the SKEW spike to historic levels (140-150) while the VIX did not necessarily follow soon after, I came to the conclusion what it simply meant was traders were buying deep out-of-the-money puts for a true Black Swan event - something like a nuclear war. However, as no real events emerged, S&P 500 realized volatility stayed low, and therefore the VIX itself didn't follow those SKEW spikes. Furthermore, the SKEW reading was below 120 in recent days.

What seemed to be the early warning this time were two market events: a melt-up (acceleration of index gains) and plunging bond prices (Treasury yields reaching multi-year highs). It wasn't that these were trends - it was that these events were happening fairly quickly - in just part of January 2018 alone! And some traders were paying attention. The VIX started to see daily positive changes along with stock indexes going higher. That meant more traders thought it worthwhile to spend money on at-the-money put options to protect gains. But it wasn't just that. Last week, the VIX saw a somewhat steady climb from under $12 to the $15-$17 level. It's hard to say whether there was one news event that brought us to today's Big Unwind. The White House / Russia investigation had bombshell news-worthy events in the past and the Nunes memo, while newsworthy, was probably not extraordinary in the timeline of events.

Also, the volatility index of the Nasdaq market is not as well known, but it showed a steady climb from about the $14 level to $20 over the past 30 days.

What seems very clear is that people should take notice when the VIX awakens from a slumber and "gains" 50% in a week without returning back to previously depressed levels.

What's next?

As of market open on February 6, 2018, both SVXY and XIV were halted until mid-day. SVXY has re-opened for trading around the $11 level, which might reflect what I estimated to be a 2/5/18 closing value of around $497M in contracts. So they've not been terminated as of mid-day 2/6/18.

XIV, however, has not resumed trading. Based on the intraday indicative value of $4.22 seen on 2/5/18, it does not appear that XIV will continue trading in its current form. It's possible we might see a new VelocityShares ETN replacement in the works.

As I stated earlier, I'm not a perma-bear. I go wherever I perceive there to be value or an arbitrage situation. When the dust settles in the coming days or weeks, if funds like SVXY, XIV, and VMIN are still standing, I may take a long position. I used to regularly sell OTM puts on SVXY when SVXY used to trade below $50. Those frequently expired worthless and I collected a nice premium.

Along the same lines, I may buy put options on long volatility - the VIX spot itself - as well as on funds like UVXY, VXX, and VIXY. As you can see from this 5-year chart below, VIX spikes have been short-lived. This tendency is unlikely to change because it costs money to keep rolling put options. Once the S&P 500 has corrected some and fear subsides, traders will no longer feel the need to keep buying puts month after month. Unfortunately, many short volatility traders have no doubt been burned or sadly wiped out from this event, and will not want to re-enter the trade when conditions are actually favorable to so. Finally, there's the chance that equities could see a real correction, at which time we should all be so happy to find real value - companies that have abundant free cash flow trading or undervalued assets, trading at much lower metrics.

(source: Bigcharts, 5-year VIX spot chart)

Disclosure: I am/we are short SVXY, XIV. 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.

Additional disclosure: I may initiate long positions in SVXY, XIV, and may go short VIX.X, UVXY, VXX, VIXY in the next 72 hours.