The Short VIX ETF Idea Was Great in The Last Year
How work VIX ETFs, and how can you earn a lot–or lose a lot–with them? One of the best investing stories of the last 12 months was shorting the VIX. While the famous Nasdaq 100 index gained 40.2 percent, the ProShares Short VIX Short-Term Futures ETF (SVXY), 44.7. And this so-called inverse VIX ETF or VIX-shorting ETF is tracking the underlying asset only in a 50 percent. By the homepage of the fund:
The ETF seeks daily investment results, before fees and expenses, that correspond to one-half the inverse (-0.5x) of the daily performance of the S&P 500 VIX Short-Term Futures Index.
Another VIX product, a certificate of Société Generale in Europe, Faktor 1x Short Zertifikat auf VIX (CU0AF6), jumped 88.7 percent in the same 12 months. (To June 4, 2021.) This product tracks the VIX -1.0x, or 100 percent inverse. And this is not even its best period possible. Between the bottom of the crash in March 2020 and today, the price exploded 245 percent (to 2.66 EUR from 0.77 EUR approximately). Of course, it was almost impossible to catch the bottom, as usual in crashes.
How Are High VIX-Returns Possible?
The SVXY in the US, in dollars, with its -50 percent exposure, returned half of what the certificate in Europe, in euros, with a -100 percent exposure, returned. And the underlying VIX futures fell only 28 percent. How is this possible? Only on behalf of the contango, the rolling gain in the futures prices, which short-sellers receive holding this positions.
Investment Returns, 1 Year
(June 4, 2021)
|Product or Index||Return|
|Nasdaq 100 index||40,2|
|S&P 500 index||32,4|
|VIX futures (nearest)||-28,0|
|CU0AF6 (VIX short certificate)||88,7|
|CU0AF4 (VSTOXX short certificate)||-4,0|
|(Sources: Investing.com, Boerse-frankfurt.de)|
In short, the VIX futures are mostly, approximately 85 percent of the time, in a strong contango. That means the longer settlements are much more expensive than the closer ones. In this case, if you buy (the nearest) VIX futures, you lose a lot every month. Because by the “rollover,” you have to exchange your expiring futures for the new, more expensive ones.
But short-sellers are earning big with this because they can sell higher and higher again, every month. More about contango and backwardation in my crude oil post of last year. And my previous chart here, showing how buyers buy high and sell low. And short sellers, at the opposite:
Do VIX ETFs Gain Ten Percent A Month?
The contango of the VIX futures often reaches ten percent per annum, incredible but true. At the moment, it is 14 percent. This is the difference between the nearest and the second settlements. (You can check it on Vixcentral. Or Barchart.com, if you don’t mind doing some divisions.) It works like some extreme high-yield bond. Ten percent a month, but with compound interest, reaches 214 percent in a year (1,1^12–1).
Yes, it would triple the value of your investment. If you can’t believe it, search for the historical data of the SVXY (e. g. Tradingview.com, Investing.com). This short VIX ETF surged to $560 in January 2018, from $20 in December 2011 (28-fold). That was near 70 percent p. a. (Before this fund’s “objective multiple” changed from -1x to -0.5x as of 2/27/2018.)
And then, here comes a big “but,” right, since there are no miracles, only in fairy tales? Exactly.
Death May Come for Them Every Few Years
Despite the astonishing yield I have described above, VIX products, especially short VIX ETFs, are very scarce today. Indeed, many ETFs were extinct before. Not even in the 2020 crash, but in another market turmoil in early 2018. SVXY also almost died; see the next chart.
VIX shorts become very ugly if the stock market crashes, and the VIX index–also called “fear gauge”–skyrockets. VIX ETFs, certificates, warrants, or other products have some limitations, rules for these cases. They will be knocked out mostly by a 40-60 percent daily jump in the VIX Futures. And these things happen roughly every 3-5 years. Not only in the greatest crashes (2008, 2020) but also in some smaller ones (2018, 2012), as you see in the last chart. (Not only the extent of the VIX futures surge is important, but also the speed of the changes.)
No Hope for Any Short VIX ETF, Then?
Is there any secure method to avoid the deadly spikes and save our gains generated in the short VIX ETFs? Not really. If there was, everybody would be rich now. You earn high returns only with products exposed to extreme risks–you can’t overwrite the ancient rule.
However, there are different methods to lower these risks. One of them is very simple: Don’t be greedy. If you can double your money every year, but every 4-5 years, once you lose it all, you can use the method of “partial profit-taking.”
You can cash out a part of your investment every year or, e. g., quarterly. So, your losses are limited, and if the VIX futures explode and all short VIX ETFs, warrants, certificates, options die, you may have decent cash (or bonds) spared.
After the spike, you can open another trade, buy another VIX shorting product or simply buy stocks when prices are favorable again. Cashing out a part of the gains, you can set your own risk level. Because it is better “being greedy when others are fearful” (like in March 2020) and “fearful when others are greedy” (many other periods in the last decades).
Others try to use options. Or are searching for signals in the volatility of the VIX index (VVIX). Some others recommend shorting a long VIX ETF (like the VXX) instead of shorting the VIX itself.
Interesting external post about shorting volatility. Look at the date of the publication: