Two investment vehicles tied to US share market volatility collapsed after the S&P500 closed earlier this morning, and it could have significant implications when markets reopen later tonight.
The two exchange-traded securities in question — the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and ProShares Short VIX Short-Term Futures ETF (SVXY) — are set up to provide one-day returns that are the opposite of the VIX Index.
The Cboe Volatility Index — known as the VIX — is used as a gauge of the level of volatility in markets.
And amid the market turmoil overnight, the S&P500 VIX Index jumped by more than 100% to close at a reading of 37.32.
According to research by Macro Risk Advisors (MRA), it meant that by the close of trade the combined value of XIV and SVXY had fallen from $US3 billion to just $US150 million.
Investment bank Credit Suisse has the the biggest holding in the XIV ETN (exchange traded note), and calculations by ForexLive indicate the bank may be facing losses of $US500 million in connection with its position.
Shares in Credit Suisse fell by as much as 6.1% in after-hours trade, but the bank said it would not incur significant losses.
“The XIV ETN activity is reflective of today’s market volatility. There is no material impact to Credit Suisse,” a spokesperson for the bank said.
So how did the two investment vehicles both suffer such a rapid fall in value?
The MRA report said as of last Friday’s close, both the XIV and SVXY funds were short approximately 200,000 VIX futures.
The VIX instruments derive their returns based on futures contracts, which also explains why their meltdown occurred at the end of futures trading.
When VIX futures spiked into the close, 95% of that short volatility risk was covered, “likely in the minutes leading up to the 4:15 futures close,” according to MRA.
Market analysts from JP Morgan and Societe Generale voiced their concerns last year that the popularity of short-VIX trades had the potential to exacerbate losses in the event that volatility returned to markets.
The possibility of more such trades unwinding adds a further layer of uncertainty ahead of Tuesday’s session on the S&P500, as Asian markets continue to suffer heavy falls in afternoon trade.
You can read more on this at BI Prime.