Misunderstood VIX Products Serve a Purpose

In the last week I have heard more about VIX from more people than I care to mention, some of whom have no idea what they are talking about. As someone who does know what he is talking about, I want to make a few points:

The letter that was sent to the SEC earlier this week is garbage. It is poorly written and factually incorrect. Last week's VelocityShares Daily Inverse VIX ST ETN (XIV) and ProShares Short VIX Short-Term Futures (SVXY) blowup was avoidable but not unsurprising. If one reads the prospectuses, both literally say they can go to zero. Short-vol products do serve a purpose: to provide liquidity to a market that mostly wants long volatility. The whole world is long stocks, hedging is popular and needs liquidity. These products provide some of that liquidity. VIX, if used as a hedge last week, did its job. In fact, a strategic long iPath S&P 500 VIX ST Futures ETN (VXX) position outperformed as a hedge relative to the selloff in the SPX. We could have called a major drop in XIV/SVXY days ahead of time as term structure of VIX futures started to move at least a week ahead of the blowup, and I would argue even more.

When the VIX was at 9, 10 and 11 everyone was piling into these products. Now that the VIX went to near 50 and the risk of a blowup is actually low in SVXY, the products are poison. This is silliness....77 more words left in this article. To read them, just click below and try Real Money FREE for 14 days.

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