The following is a guest post from Christopher M. Uhl, CMA, MOSM, Editor of 10MinuteStockTrader.Com. Today he shares his thoughts on the VIX and the various VIX ETPs, some of which melted down recently. 

The VortIX

How 2017’s Best Trade Imploded All in One Day

Have you ever wondered, “What would it look like if a stock that was 100 dropped to zero?” Well, now there is an amazing case study, the Legend of XIV. I’ve never traded XIV, but I’ve traded its cousins, SVXY, UVXY, and VXX. I just never had the chance to play with the fire that was XIV. Shorting volatility, continuing to expect a one-way bull market was the play for 2017. It just worked; but as the old saying goes, “It works until it doesn’t.” – Profound scholar.

The other scary part here is that these people who had invested in XIV actually had a heads up. They could have known this would happen on the day of impact and conversely, as I’m sure happened, one could have made a fortune overnight by shorting XIV.

The Trade of the Year Winner goes to:

2017 was a year of practically no volatility. All the major indices ended the year with over 20% gains while the VIX, the CBOE measure of the implied volatility (aka expected move) of the S&P 500 index options, continuously set new lows. As the table below shows, 18 of the lowest 20 VIX readings ever came in 2017 and the first trading week of 2018.

The XIV is an ETN (Exchange Traded Note, it’s a tradable, unsecured debt instrument similar to a bond issued by a financial institution, whereas an ETF has a financial stake in an underlying asset) that tracks the inverse of the daily percentage change of the first and second-month volatility futures contracts. So with the VIX hitting new all-time lows, one would be correct in assuming the XIV would be continuously hitting new all-time highs. Just see for yourself in the chart below, the green line is the S&P 500 whereas the black line is the XIV.

Over 2017, the SPY shows a gain of 22% whereas XIV dominated 2017, engineering a gain of 204%. Now that’s a spicy meatball! It makes the exceptional returns over the last 12 months in the broad market seem like pennies. Now there was some volatility as you can see around the midpoint of the graph, investors had to endure a roughly 50% drawdown when the first RocketMan threats were announced. But just as flies stick to honey, these investors were undeterred, their losses were recouped within a couple of months and more and more funds were poured into the short volatility trade.

2018’s Black Monday

Monday, February 5, 2018, was the Black Monday of trading volatility. The VIX index had it’s highest ever one-day point and percentage move, up 20.01 points and 115.6% as shown in the table above. This move was exacerbated by the fact that the VIX had been at historical lows for so long, leaving what would have been an above average point move to be close to double the previous max on a percentage change. So let’s just take a quick look at what happened to our favorite trading vehicle of 2017, XIV in a year to date chart.

That weird, I’ve never seen an explosion graphic on a chart before, I guess that’s some kind of a fancy new chart indicator.

I first saw that something was happening as I was scrolling through my twitter feed. Many, many, many people were saying, “What’s happening to XIV? Who is calculating the closing prices?” Even the great Jim Cramer had a few choice words on his twitter:

The closing price on Friday 2/2/18 of XIV was $115.55. The closing price on 2/5/18, the day of reckoning, was $99.00. Oh so it went down about 14%, obviously a black swan event, but what is everyone so up in arms about? The carnage came after hours. I pulled up the CNBC app and watched as the price went down, down and down some more in the vortex of termination. The opening price on 2/6/18 was $10.49 with a post-it note attached to the side saying the termination of the ETN would be completed by an irrevocable call notice on 2/15/18 with the acceleration date (the day investors receive a cash payout per share) on 2/21/18. Credit Suisse stated in their prospectus that a termination event will occur any time the closing price drops more than 80% in a single day. I doubt that anyone who had their hand caught in the cookie jar would have thought that day would actually come. The final price is not set yet, but it is expected to be between $5 and $10.

Timing was Everything

Like I mentioned above, this was 100% something that anyone following the markets and was familiar with these type of products could see coming. I’m honestly kicking myself for not having placed a short trade in XIV. I’ve occasionally traded the volatility products, all from the long volatility side, hoping for this kind of eventual move. Had I seen that it only had a 14% intraday move when the VIX spiked over 100%, I would have thought something was wrong. And had I had enough wits about me, I would have shorted it. The real damage was done after hours when the price fell off the catastrophic cliff of rebalancing. Oh well, hindsight is 20/20. On the flip side, people should know what they trade. If I had logged into my Tastyworks account, remembered I had XIV and saw it was down 14% on the day the VIX spiked over 100%, I might have thought very hard about closing my position while I could. However, anyone who was short all of 2017 and the first month of 2018 made a killing. They probably were thinking this was a great opportunity to reload as the VIX is bound to come back down quickly.

Outlier moves like this are the kind of moves that traders dream about and also have nightmares about. And while any price change can happy on any given day, an event like this is one for the record books. Don’t worry though, the lawyers are on it, just google “XIV Termination Price.” This could get a lot more interesting as the lawsuits play out…