Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 240

VIX, XIV and all that jazz

Before 2007, few people had a clue what a Collateralised Debt Obligation (CDO) was. When cash funds that held CDOs froze redemptions as the market collapsed, the loss of confidence drove what became the GFC. Suddenly, not only was mainstream media explaining CDOs, but so did bestselling books and Hollywood movies, the highlight being Michael Lewis's excellent The Big Short.

There's a scramble now to explain XIV. Bring on Lewis's next book. One day after the CBOE Volatility Index (VIX) had its largest-ever one day rise of 116%, Credit Suisse announced it would close its inverse VIX note. This VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ code XIV) lost 96% of its value on one day. It's arcane to most Australian investors, but this was a $2.5 billion listed note that many local traders enjoyed as it returned 150% per annum for the previous two years.

What happened? In brief, until the start of 2018, equity markets had enjoyed years of falling volatility. Traders used products based on the value of the VIX (the VIX is an index and cannot be directly bought or sold) to sell at say 20, and buy back at say 12 as volatility fell. The inverse note, XIV, traded on the market just like a share, and as the VIX fell, XIV increased in price. Where there's demand, Wall Street creates a product.

But many traders had forgotten about risk. As volatility returned to the market, VIX rose dramatically, and the inverse note, the leveraged XIV, collapsed.

This 'shorting volatility' strategy paid for many a Porsche out of trader bonuses. Discussion website Reddit has a 'Trade XIV' group with 1,800 members, which carried posts like: "How I made $356K on XIV in two years". Now it includes this post:

"I've lost $4 million, 3 years of work, and other people's money. I started with 50k from my time in the army and a small inheritance, grew it to 4 mill in 3 years of which 1.5 mill was capital I raised from investors who believed in me. The amount of money I was making was ludicrous, could take out my folks and even extended family to nice dinners and stuff. Was planning to get a nice apartment and car or take my parents on a holiday, but now it's all gone."

Many of the investors were friends and family. I have not attached the relevant link to Reddit because much of the language is crude.

I'll leave it to Michael Lewis to write the XIV book and explain backwardation, gamma and contango, given he will have about 300 pages. Then go watch the movie.

It's not investing. Volatility trading and the need to cover leveraged risk on XIV and other products probably accelerated the overall market decline. This activity infiltrates mainstream stocks and induces investors to panic in response to headlines and fear. Forces such as these and high frequency trading (where computers automatically issue orders and now comprise about 60% of US equity trading) can have a pervasive impact on everyone's portfolio. The consequences appear to have been contained this time, and despite the screaming headlines, the US share market is ahead in 2018 to date.

 

Graham Hand is Managing Editor of Cuffelinks.

 

RELATED ARTICLES

What does the 'fear gauge' VIX really mean?

Managing the threat of rising volatility risk

Is the current market really more volatile?

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.