From Dealbreaker - Each morning, at the market’s open, Seth M. Golden, a former logistics manager at a Target store, fires up the computer in his home office in northern Florida and does what he has done for years: Put on bets that Wall Street’s index of volatility, the VIX, will keep falling. That’s the opening line from an article that appeared in the New York Times on August 28, 2017, and it should have been a warning. To be sure, it spawned its fair share of derisive memes that spread like wild fire among market participants who understood how patently absurd the idea of former Target managers shorting vol. for a living really was, but it should have set off louder alarm bells. That is, this should have been flagged by regulators as something that was inherently dangerous. Now I’m not exactly sure what could have been done, because the horse left the proverbial barn on this years ago, but if anyone outside of sellside derivatives desks had taken the time to actually do the math and connect the dots on the type of systemic risk the doomsday vehicles used by Seth and his ilk were embedding in markets, it would have been immediately clear that this was bound to go horribly awry one day with God only knew what consequences. I’m not going to regale you with the tedious details (there’s more than you would ever want to know in my “doom loop” archive), but generally speaking, there are two critical issues, one of which has implications for the broader market. The first problem with inverse VIX ETPs is that because of the low starting point for vol., even a nominally small spike looks fucking huge in percentage terms. Well, some of those vehicles have what amount to knock-out clauses in the prospectus which effectively means that in a particularly acute scenario, the products are liquidated/redeemed. On that score, February 5, 2018 is “a date which will live in infamy” for Target managers-turned vol. sellers. The VIX spiked 100%+ at one point on Monday and headed into the close, there was a palpable sense of concern about what that might mean for the Seth Goldens of the world. Sure enough, after the bell, XIV collapsed 80%: All you had to do to confirm your suspicions that retail investors never read the prospectus on XIV was tune into Twitter and StockTwits where thousands of Target managers were losing their minds in real-time trying to figure out what had happened. As I put it while this was going down: “Hey guys? XIV looks like it might be done.” While Credit Suisse was mum on Monday evening, we got what amounted to confirmation that the worst case scenario was indeed playing out when Nomura announced that the Next Notes S&P500 VIX Short-Term Futures Inverse Daily Excess Return Index ETN would be redeemed, after one of the conditions was triggered due to movements in the underlying index. Fast forward 12 hours (give or take) and the black swan landed. Credit Suisse pulled the plug on XIV. To be clear, not every one of these vehicles suffered the same fate and the conditions for “acceleration events” vary, but the overarching point is that retail investors clearly did not understand that this was even possible. And because they couldn’t even be bothered to read the prospectus which spells out how and why a given fund can effectively terminate at the drop of a hat depending on market conditions, you can be damn sure those investors had no idea why the trade was working in first place. But hey, “there’s always Target”, right? I mean, assuming you didn’t tell your superior to go fuck himself before triumphantly throwing your name tag on the floor and walking out during the middle of a shift after you made your first couple of hundred thousand shorting vol. via products you didn’t understand. On a more serious note (and this is the second of the two problems mentioned above), levered and inverse VIX ETPs present (or actually “presented” because it’s to a certain extent past tense now) a sizable rebalance risk. And see this is where someone (regulators, anyone) should have said something. Those things are effectively forced to panic buy VIX futs into a vol. spike if said spike is large enough. That rebalance has the potential to exacerbate an already bad situation depending on what the vega-to-buy looks like. Depending on liquidity, that could be difficult for the market to absorb. It certainly seems as though that risk was realized on Monday and it likely contributed to the chaos that unfolded over the last hour of trading on Wall Street, chaos which continued after the close. As ridiculous as it seemed at the time the NYT article was published, anyone who knew anything about this realized that the evolution in market structure that was behind the Seth Golden story had the potential to crash the market one day. The proliferation of short vol. strategies embedded a material amount of systemic risk into markets and just to be clear, it is not 100% clear that this is over. While the deck has been cleared in terms of the VIX ETP rebalance risk, a sustained spike in vol. has the potential to cause an unwind in systematic strategies. Whatever the case, now everyone suddenly understands that there’s a limit when it comes to how much market democratization is desirable. As pretentious as it might sound, retail investors have no business whatsoever explicitly shorting volatility. That was (always) absurd on its face. The bottom line is that the proliferation of short vol. products was an example of financial market democratization gone too far. There are certain things you do not want the guy in charge of stocking the shelves at your local big box retailer doing, and it turns out that shorting volatility is one of those things. Who knew trading VIX futures wasn’t as simple as making the cigarette break schedule at Walmart? Apparently not regulators.
Jack, Wasn't my quote. That was part of the article. For what it's worth stupidity usually takes care of itself. Cold as the North Pole in Chicago. What the temp down under?
I would have imagined that guys who "sell vol for a living" ought to lurk around doing nothing much, until one of the black swans eventually hits accompanied with a huge VIX spike, like Monday, and then back up the truck to short it once you get a feel for where things are. Why would someone constantly short VIX long term on a daily basis, to short every minor pop, in record low volatility regime that everyone has been saying for months and months is a record breaking statistical anomaly in calmness? I suppose the returns will suck just waiting around and real wealth be destroyed by inflation. I suppose it will feel like you're not making progress for ages, on a day to day basis. But that's how this line of work should be right? Kinda like how actors make a living. They don't get a monthly salary. They do a hit movie and get paid millions in a lump sum. Then they live off that, and until their next gig comes along, get paid lump sum again. Short vol guys should be like that right? Make no money for ages, then bet the farm when the situation is right and earn a lump sum to live on. Rinse repeat. And maybe to play both sides. Maybe long volatility when historically low vol then flip to short it when it spikes.
@beefcaketrade, the guy in the article (and with him a lot of others) shorted vol through either buying the inverse ETN's (like XIV or SVXY) or selling the 1x or 2x ETN (like VXX, UVXY)... probably to capture the almost constant roll. This was because the VIX futures are/were usually in contango and the ETN's are based on the first two futures.. which means the price of something like the VXX constantly drops slowly. So it's not that he shorted vix futures everyday... but was just "hodling" these ETN's... which worked fine... Until it doesn't because the VIX goes up... which was to be expected at one time or another, because simply it has been very low... so a small move up in absolute terms is a large one in %... which means those ETNs move like crazy... and poof... it's gone. Which is how stupid trades work... it worked before so it should work in the future... not acknowledging the risks because of a lack of understanding how financial markets work...
There is nothing wrong, in principal, with consistently selling vol* to capture the roll - if you are aware of the risks and manage them. The total return to shorting the VIX is still significantly positive - it's not like accidents such as those on Monday wipe out all your accumulated profits if you've been doing this for 15 years. That means in practice you should probably not do so via leveraged ETNs (on which the pre-set leverage means you can and will be wiped out) but via futures where you can set the leverage at the appropriate level. That means you should scale your position so that an overnight doubling, or tripling, of vol is something you can survive. (* Ok you can do slightly better: don't trade the very front contract which although it has the best roll also has the highest skew, maybe throw in a trend following filter on the underlying to try and get yourself out of the car accident before it happens [this probably wouldn't have worked on monday, but at least it means you won't get back in again until there is a clear downward trend in vol established], only sell when the future is in contango [backwardation is a sign of high stress, and also means you're not being paid for shorting, though again this won't get you out in advance, but will stop you getting back in too early], and sell less when the VIX is really low in absolute terms [though this is often when the roll is the highest]; but none of these will be a get out of jail free card that allows you to earn the premium from shorting vol whilst avoiding the horrendous drawdowns) GAT
Here is an update- https://www.google.com/amp/s/qz.com...iv-and-svxy-for-a-living-hes-still-at-it/amp/
ETN's are the right way to trade this. For a small management fee you cap your max loss at 100%. You can set the leverage by managing the weight of the ETN in your portfolio.