Inverse Volatility Products Almost Worked

We have talked a couple of times this week about the unpleasantness experienced on Monday by investors in inverse volatility products like XIV (the VelocityShares Daily Inverse VIX Short-Term ETN, an exchange-traded note issued by Credit Suisse) and SVXY (the ProShares Short VIX Short-Term Futures ETF, an exchange-traded fund). These products were bets that volatility would go down. On Monday volatility went up. Specifically the VIX (the CBOE Volatility Index) went up by 116 percent in one day. The people who had bet that volatility would go down lost almost all of their money. That is altogether fitting and proper. When you bet that a thing will happen, and the incredibly extreme opposite of that thing happens, then you should lose your money. You can complain, but we don't have to listen to you.

So in the broad sense those products worked as intended. For instance, if you bought XIV at noon last Friday, you paid about $119, when the VIX was about 15. At 4 p.m. on Tuesday, when the VIX was at about 30, your XIV was worth $7.35. The VIX had gone up by 100 percent; your XIV note had gone down by about 94 percent. There is some tracking error, because the XIV isn't exactly meant to provide the negative of the return on the VIX -- it provides the negative of the return on a blend of short-term VIX futures1518026480209 -- but basically the XIV going down by 94 percent when the VIX went up by 100 percent seems about right.