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06
Feb

Instruments Of Death XIV & SVXY; Investors Destroyed Afterhours

Naturally, all good things come to an end. I can’t remember the last time I saw SPY down 5% in a single day. The never-ending bull market built on the backs of a superficially growing economy has just been unwound, dismantled, and laid bare before you, over the span of 2 trading sessions. I have been somewhat able to sidestep the carnage, being long only one fracking stock, but nevertheless was not completely immune to the pain. Plus, it’s not over yet.

But nevermind those losses in tech, let alone the crypto market. The more important subject at hand are these 2 vehicles of death, leveraged ETFs SVXY & XIV – securities that serve no other purpose than the fulfillment of hubris and greed. After markets closed, they traded down to the tune of 80%, wiping out shareholders almost completely.

The concept of leveraged ETFs never made any sense to begin with, and still don’t make any sense now. The premise behind them is simple; why buy an index when you can do the same thing and make 2x, or 3x, with just a simple tweak of the asset structure? This is a mindset that sells since no one is content with plain old vanilla gains anymore. Asset managers have production numbers to meet, and if they are going to own the index funds anyways why not make it double? After all, markets only go up nowadays don’t they? Underwriters have understood this and have minting fees off these leveraged products for as long as I’ve known the markets.

On to the volatility index.

Contrary to what people think, the VIX no longer tracks volatility. When the markets rip higher, it drops. When markets are stable, it drops. Only when outlier events, such as today occur – leaving markets down 5%, do they react and move appropriately higher – only to slowly fade lower again as the fear in the market slowly vanishes. The VIX has been a no-brainer short in the financial community, and in light of that, came the inverse side to it; VXX. Then the leveraged versions; XIV and SVXY.

How do they work, you ask?

Simply put, when the VIX drops 1%, VXX will gain that amount. XIV will do the same, but double, and SVXY 3x. Being that the VIX does nothing but drop lower and lower, these securities have been on the other side of that trade, running higher over the past few years almost indefinitely, like clockwork. Easiest investment ever.

But wait.

Buried deep in the prospectus of these god forsaken instruments lies a risk: if the VIX were ever to double in any given trading day, the value of these leveraged inverse volatility securities would crater to below 0. Yes, a one off event that would trigger a spike in the VIX, like today, would send the value of these securities straight to fucking zero, AND LOWER. Anything below that and the underwriter would have to eat the loss. Couple that with the fact that these underwriters are actually short the VIX futures to create these inverse ETFs in the first place and you get a short squeeze of overwhelming proportions – exaggerating moves way beyond the point of rationality. Nobody wants to be left with an unlimited amount of losses and they have every right to cover their positions.

Here are the results, have a gander.

Remember, this has been a fail-proof investment for many asset managers over the past few years. If you had stepped in and bought the market close today at $99 – a completely reasonable decision, you would be completely wiped out by now, and would have had the opportunity to do absolutely nothing about it but watch.

Fucking nuts.