Why VIX ‘Acceleration Events’ And Extreme Short Interest Signal “Clear Path To Uglier Scenarios”

Jon Market Commentary

VIX ETFs and ETNs
We take a deeper dive into the strange world of VIX ETFs and ETNs. We take a quick look at the incredible short interest in both the long VIX products and the short VIX products. This massive short interest in both long and short products seems unique to the VIX world (it reflects a re-balancing trading strategy that works in the VIX space because of the high volatility of the VIX products) (VIX ETFs seem to run 5 to 10 times the realized volatility of the S&P 500).
Then we dig into the prospectus for each of the 4 funds I focus on (VXX, UVXY, XIV and SVXY).
What is important is the Acceleration Event in XIV. The language from the prospectus seems clear that if the VIX Short Term Futures Total Return index moves 80% in a day, then XIV has to unwind. While an 80% move in a single day is very unlikely, I believe that the lower VIX goes, the easier it is for it to occur (VIX at 8 only needs to jump to 14.4 in a day for this to occur), because these VIX products make a ‘mistake’ in my view of converting changes in VIX to percentage changes to provide returns (the VIX futures do not do that for example).
The problem with an XIV acceleration event is two-fold – all of the hedges (short futures positions it has) will need be covered, just as the market is struggling. The second order problem is that many investors who have been waiting for a spike in VIX to sell volatility won’t have an outlet. If you planned to buy XIV on a VIX spike and it isn’t there, what do you buy? It is far less clear what sort of trigger mechanism SVXY has (that is something we are looking into).

This post was published at Zero Hedge on Jul 23, 2017.