Short-term update: this analysis was both a cover story and most popular on Zero Hedge. Check it out and share with your friends! Bear in mind that market rallies occur, during stressed markets and high risk periods (such as the higher volatility regime we are in)..
Now we have a new year, with a carryover of the same volatility pick-up that started in August 2015. For several years prior to August, it was the calamitous VXX ETF that was doing poorly; now it is the opposite-flavored XIV ETF that is being ravaged. We'll show how in just a couple August weeks, the recent long-term low-volatility regime (which hedge funds carp about for their horrific performance) had suddenly switched to a high-volatility regime. While this Black Swan turn-around was dramatic (see before and after discussions here, and here), we see on the other side more difficulties with these volatility products. Before August we saw a brutal evisceration in VXX (a geometric collapse of -0.3% daily) with 6-month lows (and even all-time lows) happening weekly. The XIV on the other hand gently rose 0.1% daily and achieved 6-month highs (and even all-time highs) semi-monthly, and in a fascinating Zero Hedge articles (here, here), they shrewdly showed that shorting volatility yielded a >50% return. And they also noted that the musical game of this strategy would end disastrously. This reversal has now come in full exorbitance, as the four volatility regimes of the past >5 years are shown below.
We had noted earlier that August 2015 represented a couple weeks of unexpected fury from a market that had grown negligent, and a month where a lot of record-setting destruction took place (including August 24: China's Black Monday). In those 16 days, the VXX doubled as a multi-year short-squeeze jerked open like an tightly-wound Jack in the Box, while the XIV was more than halved. Years of gains on the XIV gone in days! Then during the 2-week intense market bounceback in mid-September, through to today, the VXX has essentially remained the same while the XIV continues to crater an additional ¼!
To understand the bounceback in September, followed by five months of volatility pick-up again, we should study our previous pairs of articles on this topic (here, here). The summary is that these volatility products decay faster than you would have the opportunity to profit from them. And these volatility regimes recently, being so brief, provide only a small fraction of all traders a chance to profit (and only ½ of those through skill). The distribution of VXX and XIV are more symmetrical now given the recent regime flips, except the distributions are even more firmly centered below 0%, making profiting from them nearly impossible even for finance immortals. The links in this paragraph show that reasonable strategies see these products losing value, even when the underlying VIX curve moves in a correctly predicted direction. To put these losses in perspective, the all-time low in the VXX was in August 2015 (it hasn't made a 6-month low since then!) Meanwhile the XIV peaked twice at a price above $49 (the more recent also being August), and it has never made a 6-month high since then. Though XIV now makes 6-month lows, 2-3 times a month. More on these statistics later.
If one had simply held a 50/50 portfolio of VXX/XIV (without rebalancing) for the several years shown -that is prior to the August crash- then their returns would have been >150%. And instead if one were later long VXX and short XIV in just the past six months (mostly due to the August tumult but even including the subsequent temporary rally as well), their returns would be >450%. Both of these results are exceptional, and regrettably couldn't hope for either one going forward.
The final high-volatility regime (high-vol2) that we are now in covers five full months. It's not simply a just-happened phenomenon. Never mind that the major Wall Street strategists again predicted that 2016 will see markets rise 8%, and now already have retreated on this with new bullish forecasts from these depressed levels. A recent 5-day down market streak has caused markets instead to be showing a possible bear market instead. And their fortune cookie resemblance can not think of anything negative to say. Meanwhile the XIV has been crumbling at -0.6% daily (twice the noted implosion rate of the VXX during the multi-year bull-market ending August 2015!) With the 4% rally in the XIV today, it's right to ask if perhaps traders are suddenly crowding into a short trade with this fund, which uncoiled in a anomalous way! If so, then don't count on many more of them in the near future.
In summary, these volatility product decays occur continuously and quickly, even during brief slides (as opposed to outright nosedives where obviously one can make a profit killing). Even with a prolonged high-volatility regime that we're in now, it's just as treacherous to employ either product for the long run. They will continue to always make new lows, and never new highs. Over the course of just a year, both the XIV and VXX will break your portfolio and your heart, if regulators do not act in time. There are of course myriad other foolish decisions that you or your Wall Street wealth manager can make instead. It's worth noting that since September 1, neither product has made an all-time high (let alone 6-month high). It's also very likely that such a high may not come at all, this year.
Now we have a new year, with a carryover of the same volatility pick-up that started in August 2015. For several years prior to August, it was the calamitous VXX ETF that was doing poorly; now it is the opposite-flavored XIV ETF that is being ravaged. We'll show how in just a couple August weeks, the recent long-term low-volatility regime (which hedge funds carp about for their horrific performance) had suddenly switched to a high-volatility regime. While this Black Swan turn-around was dramatic (see before and after discussions here, and here), we see on the other side more difficulties with these volatility products. Before August we saw a brutal evisceration in VXX (a geometric collapse of -0.3% daily) with 6-month lows (and even all-time lows) happening weekly. The XIV on the other hand gently rose 0.1% daily and achieved 6-month highs (and even all-time highs) semi-monthly, and in a fascinating Zero Hedge articles (here, here), they shrewdly showed that shorting volatility yielded a >50% return. And they also noted that the musical game of this strategy would end disastrously. This reversal has now come in full exorbitance, as the four volatility regimes of the past >5 years are shown below.
We had noted earlier that August 2015 represented a couple weeks of unexpected fury from a market that had grown negligent, and a month where a lot of record-setting destruction took place (including August 24: China's Black Monday). In those 16 days, the VXX doubled as a multi-year short-squeeze jerked open like an tightly-wound Jack in the Box, while the XIV was more than halved. Years of gains on the XIV gone in days! Then during the 2-week intense market bounceback in mid-September, through to today, the VXX has essentially remained the same while the XIV continues to crater an additional ¼!
To understand the bounceback in September, followed by five months of volatility pick-up again, we should study our previous pairs of articles on this topic (here, here). The summary is that these volatility products decay faster than you would have the opportunity to profit from them. And these volatility regimes recently, being so brief, provide only a small fraction of all traders a chance to profit (and only ½ of those through skill). The distribution of VXX and XIV are more symmetrical now given the recent regime flips, except the distributions are even more firmly centered below 0%, making profiting from them nearly impossible even for finance immortals. The links in this paragraph show that reasonable strategies see these products losing value, even when the underlying VIX curve moves in a correctly predicted direction. To put these losses in perspective, the all-time low in the VXX was in August 2015 (it hasn't made a 6-month low since then!) Meanwhile the XIV peaked twice at a price above $49 (the more recent also being August), and it has never made a 6-month high since then. Though XIV now makes 6-month lows, 2-3 times a month. More on these statistics later.
If one had simply held a 50/50 portfolio of VXX/XIV (without rebalancing) for the several years shown -that is prior to the August crash- then their returns would have been >150%. And instead if one were later long VXX and short XIV in just the past six months (mostly due to the August tumult but even including the subsequent temporary rally as well), their returns would be >450%. Both of these results are exceptional, and regrettably couldn't hope for either one going forward.
In summary, these volatility product decays occur continuously and quickly, even during brief slides (as opposed to outright nosedives where obviously one can make a profit killing). Even with a prolonged high-volatility regime that we're in now, it's just as treacherous to employ either product for the long run. They will continue to always make new lows, and never new highs. Over the course of just a year, both the XIV and VXX will break your portfolio and your heart, if regulators do not act in time. There are of course myriad other foolish decisions that you or your Wall Street wealth manager can make instead. It's worth noting that since September 1, neither product has made an all-time high (let alone 6-month high). It's also very likely that such a high may not come at all, this year.
No comments:
Post a Comment