Why Inverse VIX ETFs Are Dangerous - YouTube

Hey Everyone!

Welcome to another lesson from NavigationTrading.

In this lesson, I want to talk to you about Inverse VIX ETFs.

There is a lot of confusion around Inverse ETFs in general, but I want to focus specifically

on Inverse ETFs related to the VIX because they are just a completely different animal.

Let's take 30 seconds just to update you on the VIX in general.

What is the VIX?

It's a volatility index, or sometimes called the fear index.

It was initially conceptualized back in the late '80s, kind of around the 1987 crash as

a way to index uncertainty or fear in the marketplace.

Then, in the early '90s, they updated the VIX with the ticker VIX, which it holds today.

Then starting in 2004, they started updating it daily and utilizing the same calculations

and methodology that we see in the index today.

A few things to know about the VIX is one, it's typically inversely correlated to SPX,

or the S&P 500 Index.

The VIX is priced based on options of the SPX.

When the S&P 500 is going up, typically the VIX is going down.

When the S&P 500 is going down, and there's more uncertainty in the marketplace, many

times you'll see a spike higher in VIX.

Now, you can't trade shares of VIX, it's an index, just like SPX or RUT.

However, it does have options that are tradable, and they're extremely liquid.

The pricing of the VIX options are based on the price of the VIX futures.

Just to recap, the price of the VIX is based on options of the SPX.

But the price of the VIX options are based on the price of the underlying VIX future's

contracts.

If that sounds confusing, I know, it is, and that's exactly why we created an entire course

all about trading the VIX.

It's called How to Trade the VIX with 92.3% Accuracy.

It provides all the details that are beyond the scope of this video.

Now, let's jump onto the platform and discuss the topic of this video, which is Inverse

VIX ETFs.

Here's a list of six different Inverse VIX ETFs.

ZIV, EXIV, VMIN, XIV, XIVH, SVXY.

Now, all of these Inverse VIX ETFs are calculated a little bit differently.

Let's take a look at the platform and I'll show you exactly what I mean.

Starting with ZIV.

If you look up here, we're in the ThinkorSwim Trading Platform.

You can see that this one is managed by Credit Suisse, and it's an ETN, or Exchange Traded

Note.

Below is a price chart going back about a year and a half.

At the time of this recording, it's September 27th, 2018.

What you'll notice is that going back, if you look all the way through 2016, and 2017,

when the market was rallying, you could see implied volatility continue to contract, therefore

an Inverse VIX ETF did very well.

In fact, there were hedge funds and multiple funds made up all around this strategy of

simply selling volatility or buying Inverse VIX ETFs.

Until earlier this year, we saw in the first part of February, the market went down about

10% or 11% and the VIX exploded increasing about 115%.

Look what happened to this inverse ETF, it had a high of $94, and within just a matter

of days you can see it bottomed out at around $60.

So lost nearly 30% of its value just in the matter of a couple weeks.

One of the other things that we always want to be aware of is does this symbol have options

and are they tradable?

In the case of ZIV, ZIV doesn't even offer options to trade.

As you know, at NavigationTrading, we're all about trading based on statistics and probabilities

utilizing options to make those trades.

In this case, ZIV doesn't even have any options.

Let's take a look at the next one, EXIV.

Again, EXIV has no options either.

If you look at the volume of shares traded, we're talking about less than 500 shares traded

in one day.

If we go back and look at the same thing on ZIV, you've got about 3700 shares trading

for the day, which is very, very low.

These are symbols that I wouldn't even touch with a 10-foot pole, because they would just

be difficult to get in and out of with very wide bid-ask spreads, which eat directly into

your profits.

But let's take a look at the chart of EXIV.

During that same period in early February, there was a high of 61, and it got down to

under 30, so lost over 50% of its value in just a couple weeks.

Remember, that's because this has an inverse correlation or an opposite correlation to

the actual VIX.

So when the market went down, and the VIX exploded, this ETF declined significantly,

over 50%.

Let's take a look at the next one, VMIN.

If we take a look at the chart, what you'll notice here is that this had an even more

magnificent drop.

It had a high of over $46, and then after the little blip in February, you can see that

this one basically is non-existent anymore.

Same thing with XIV, and this was the one that got the most press, because it had the

most dramatic drop.

It was over $146 prior to that February drop.

Then, it went down to under $6 at one point.

Credit Suisse, who's the manager of this ETN, closed the door and shut it down completely.

This one actually had substantial liquidity and was heavily traded, but in this case,

people who were buying this and just playing that volatility selling game got hurt really

bad, and basically lost everything if they owned shared of XIV.

And a very similar story with XIVH.

In this case, it had a high of 82, dropped down to a little over $11, it hung around

a little bit longer, but ended up getting shut down in June of 2018.

Now, SVXY was the most liquid of all these symbols.

If we go to the trade tab in ThinkorSwim, you can see these are penny-wide bid-ask spreads

if you're buying and selling the underlying symbol.

You've got volume that's not great, but it's over 990,000 shares traded.

And SVXY actually has somewhat tradable options.

These are not options that personally I would trade, because the open interest on these

strikes is under 100 contracts.

If you look at the bid-ask spread, you're looking at 2.12, 2.35, that's just a wide,

wide bid-ask spread.

But let's take a look at what happened to SVXY during that February period.

It was at over $557 and dropped down into the 50s, losing nearly 90% of its value.

Now one thing SVXY has done since is prior to that February decline in the market, SVXY

was not only inverse, but it was also a leveraged ETF, meaning it was tracking the opposite

play of the VIX, and it was doing it at a 2x level.

It was overly leveraged.

Since the February decline in the market, they have changed up their calculation and

now their inverse exposure is at .5 or half that of the VIX as opposed to two times that

of the VIX.

As you can see, these are extremely dangerous products to be trading.

If for some reason, you still want to dabble on these, and you still want to trade them,

here are the main concerns that you want to be aware of going in.

One, liquidity, you've got to see what kind of volume in open interest they are trading

at, whether you're buying and selling the actual shared, or if there are tradable options

on those symbols that you're trading.

The other thing to keep in mind is that, as you saw, some of those symbols that we were

looking at were not necessarily ETFs, but [inaudible 00:09:09] called ETNs or Exchange

Traded Notes.

The difference is an ETF tracks an underlying index, or an ETF, however an ETN is an Exchange

Traded Note that is issued by a financial institution, like Credit Suisse.

If you're investing in an Exchange Traded Note, you want to be comfortable with the

issuer of that note, because if they go out of business, then you have liability or exposure,

because you're invested in that note that was issued by that specific bank.

What's the likelihood of a company like Credit Suisse going out of business?

I would say very small.

But remember, back in 2008, Lehman Brothers, Bear Stearns, these were staples on Wall Street,

and they no longer exist.

Anyone who had Exchange Traded Notes issued by them, had potential exposure and suffered

losses that were unrelated to the actual directional price of the underlying symbol.

Lastly, you need to understand leverage.

Remember what I said about SVXY, previous to the February decline in the market, they

were 2x leveraged of the VIX symbol.

After the fact, they changed that to be .5 exposure inversely related to the VIX.

If you don't understand this exposure and you don't understand the underlying management

of these ETFs, or ETNs, you could be exposed to risk that you're not aware of.

Make sure you understand the management and leverage of the underlying symbol that you're

trading.

So, what's the alternative if you want to have that specific exposure?

If you want to be short VIX, if you want to be short volatility, what else can you do?

Here's a couple of options.

One, you could be long SPX related stocks or ETFs.

Remember, the VIX and SPX are inversely correlated.

So if your assumption is that volatility is going to contract, then you must also assume

that the S&P 500 or related market stocks or ETFs will be going up so you could simply

get long SPX related stocks and ETFs.

You could buy SPY, you could buy Apple, you could buy Amazon, there are dozens, and dozens

of stocks and ETFs that are highly correlated to the S&P 500.

Or, as we detail in our course, How to Trade the VIX with 92.3% Accuracy, one of the strategies

that we teach is how to use options to trade short positions on VIX related ETFs.

Both of these solutions are much better alternatives to trading Inverse VIX ETFs.

Remember, as successful traders, we never want to put ourselves in a position of potentially

getting knocked out of the game.

Our goal at NavigationTrading is to always continue to hit doubles and singles, and limit

your risk exposure so you can continue to trade successfully over the long term.

I hope this lesson has helped you get a better understanding of Inverse VIX ETFs.

If you have any questions, you can always contact us anytime.

Happy trading.