The Death of XIV: A Warning To All ETF & ETN Traders - YouTube

Hey guys its MHFIN.

Todays video is the story of XIV also known as the “Velocity Shares Daily Inverse VIX

short” a previously famous financial product with a story that left behind in its path

a trail of greed, luck, and the unexpected.

To begin this tale we have to go back to 2008.

Back to the financial meltdown which devastated the market but ushered in a new decade that

featured a period of continued stable growth.

This turned out to be the start of a seemingly endless bull run that still continues to this

day.

In this period many traders were drawn to a new set of financial products that become

incredibly profitable.

Inverse Volatility shorts.

The most famous of these was known as the "Velocity Shares Daily Inverse VIX short"

better known as XIV.

It became the center piece of this new strategy sweeping the market.

Described as an exchange traded note that was created to give traders the chance to

profit when volatility went down, the way it worked on its surface was rather simple.

The calmer the market the more profitable the product.

Given the stabilization and continued growth of the market post 2010 the XIV become a legendary

asset, a way of earning easy money.

Traders flocked to its miracle like performance.

At one point it had returned a 2200% profit in 5 years.

Like all bubbles it drew the attention of the internet spurring groups like Reddits

/r/tradeXIV where one member named Lilkanna even claimed to have turned her initial 50k

investment into nearly 4 million by simply trading this speculative product.

Millions of investors were drawn into one the most complicated products in the financial

market but very few actually understood the mechanics and dangers lurking under the hood.

See XIV was in simplistic terms a ETN that attempted to follow the inverse of the VIX.

The VIX on the other hand was another financial product that attempted to measure market volatility.

This simply meant that the XIV was meant to be profitable if the market was calm and stable.

On the surface this was easy to understand but under the hood it was much more complicated

(get ready for a headache)product.

To understand lets start with some simple facts

Officially named the VelocityShares Daily Inverse VIX Short Term Exchange Traded Note

XIV traded like a stock meaning you could buy sell and short anytime the market was

open including the pre-market and after-market time periods.

In its peak is averaged a daily volume of 29 million shares making its liquidity excellent.

Like a stock XIV shares could be split or reverse split and could even be traded in

your typical IRA.

But unlike stocks owning XIV did not give you a share of a corporation.

There was no quarterly reports, no sales, no dividends, no earnings, and no profits/losses.

To make it even more obscure XIV wasn’t even driven by its supply and demand.

What???

So how did it work?

Well that awnser gets quite complex but you can check out a really interesting MoneyTalks

video on this topic if your interested in the details In my attempt of explaining I'm

going to condense down much of the information.

To understand how the XIV works you have to understand how it derives it value, and the

way it does that is by tracking the inverse of another index called the "S&P 500 VIX Short-Term

Futures Index" which in itself manages a profolio of two nearest to expiration VIX futures contracts.

These two futures contracts essentially dictate the price of XIV which in reality is just

a really complicated way to say the XIV attempts to inverse market volatility.

Now underneath the hood of this monster things can get really really complicated and go way

beyond the scope of this video.

The reason I'm using phrases such as "ATTEMPTS to inverse the VIX" is because there are many

asterisk in this product that can cause things to go haywire.

One of the biggest of these asticts was printed in XIV prospectus which is sort of like a

brochure of how things work.

In that there is a specific section regarding an acceleration clause.

Unfortatnley for many casual investors failed to read this document nor understand the risk

associated with this product.

The acceleration clause stated if the VIX futures index that it tracks happens to go

up 80% in one day they can shut down the entire product.

Now similar language can be found in many inverse volatility products and the reason

for that is rather simple.

If the XIV tracks the inverse of these futures and the futures go up up 110% whats the inverse

of that?

Its quite possible that under an extreme event the XIV could in theory hold negative value.

The firms DO NOT want this to happen and will do anything in their power to prevent it including

liquidating the entire product.

Now the chances of this were rather small but following Murphys law you can almost guess

what happens next.

This is of course where the story turns for the worst.

On Feb 5th, 2018 the VIX futures the XIV tracks jumped 100% doubling in one day.

That afternoon the notes price fell from $75.59 to $4.22 by 5:10PM triggering the acceleration

clause.

The product was liquidated the next week and thousands of investors who had made a fortune

on the product lost it overnight including reddit user Lilkanna who claimed she had lost

4 million dollars much of which belonged to close family and friends.

She was even featured in MarketPlace article that described her experience.

This story should act as a reminder to those trading complex products that I see are very

popular among novice trading circles.

Please understand the risk associated and read the prospectus.

Don't but all your eggs in one basket and make sure you are clear on how the product

derives its price.

Thank you guys for watching, please don't forget to sub, comment, and like!