XIV is an ETF that inversely tracks the VIX.
To the uninitiated, the VIX is the so called ‘fear index’. It spikes like a motherfucker when the shit hits the fan, (see below) but most of the time ticks down.*
Today the VIX index ticked up by 3.86%. Now you would expect the XIV to tick down (note the inverse letters, very clever stuff) – but it went up by 4.16%.
To emphasise how odd this is by buying XIV (and I have, indeed, bought XIV) I am effectively short volatility and should only benefit when it goes down, but somehow it went up and XIV went up as well.
There’s a good reason for this.
The VIX is an index based on options.. it doesn’t actually exist, but you can calculate it. Not actually existing has never stopped anyone in finance from trading something, so all you need is someone to take the other side of the bet and off you go. There is a very developed market for VIX futures. (If the futures get out of whack with the options you could arbitrage the difference, and this keeps it in line.)
To create an ETF you need something behind it that covers the PnL. In this case, the ETF XIV owns the closest future, and each day sells a portion of it and buys the next month. So if it currently owns the April vix future, it will sell it down over the course of the month and buy the May future.
And this is the key to the riddle. Because lately the difference between the front future and the next in line has been ranging from +20-50%. So XIV gains 20-50% every month if all things stay the same.
It’s equivalent to selling 1/30th of your portfolio at 21 and buying it back at 14 every day each month.
The catch is obviously that this can reverse, and lose every month, which happened in August. But for now, I’m going to earn that yield, and fortunately, because this is an inverse ETF, you can only lose what you put in.
As I once got told by an otherwise incredibly dim-witted and dull person (who in any case was just repeating what someone told him), when vol is low you should be selling, and when vol is high you should be buying.
Vol is currently low, and I’m long XIV – so short volatility, but will earn the future spread – and will cream off the profits and save them for a rainy day.
Everyone follow that?
*As an aside one of
my pet theories the fundamental market laws is that markets have a default mode and a panic mode… for example stocks can be relied upon to tick up no matter how high they have gone, but in panic mode they will crash down. Currencies are the same.. the aussie dollar can be expected to tick up, unless there’s a panic when it tends to crash. Sounds obvious but it goes against conventional market theory… it sure as hell isn’t symmetrical. Never fight the default mode.