Shorting Volatility with SVYX: Because Risk Management is for Losers and Black Swans Do Not Exist

Apparantly I haven't learned jack shit from the "Volmageddon" event of February 5th, 2018 when the VIX (Wall Street's "oh fuck" meter) spiked over 100%+ and wiped out a handful of inverse volatility exchange traded products (RIP XIV), so here I am shorting volatility again. Stonks only go up, J-Pow and the Plunge Protection Team are here to save my bleeding portfolio. Alright, so the genera idea is that shorting volatility proved to be very profitable historically. The stock market generally 1). trends upwards over time; and 2). volatility reverts to the mean. Because you can't buy the VIX directly, you have to rely on VIX futures. Because of factors 1 and 2, VIX futures drift lower over time, so all you have to do is being short a product that is long volatility (like VXX, dangerous because shorting exposes you to unlimited risk) or being long an inverse product (like SVXY, which caps your loss at how much you paid for your position). The value of SVXY is set by the market, but it’s closely tied to the daily percentage moves of the inverse of an index (S&P VIX Short Term Futures) that manages a hypothetical portfolio containing VIX futures contracts with two different expirations. Every day the index methodology specifies a new mix of VIX futures in the portfolio. On a daily basis SVXY moves in the opposite direction of the index with a leverage factor of -0.5X, so for example, if the index moves up 0.3%, then SVXY will move down precisely 0.15%. Remember, the VIX usually trends downwards save for occasional market panics. So what's the catch? Well, the issue with going short VXX (or better, being long SVXY) is those occasional big spikes, like the one in 2008, February 2018, and recently during the COVID crash of March 2020. SVXY went through some serious trauma in February 2018.  An unprecedented VIX spike and a VIX futures liquidity gap in the late afternoon of February 5th, 2018 resulted in a 90% drop in SVXY’s value and the XIV —a similar fund.  On February 27th, 2018, Proshares reduced the chances of a similar event in the future by lowering SVXY’s leverage from -1X the daily moves of SPVXSP, the VIX futures index it tracks, down to -0.5X.  This change reduces the chances of a similar drawdown, or of the fund terminating but also reduces the upside potential of SVXY.  So the trick is to find a strategy that goes short VXX or long SVXY, but at the same time, doesn't lose much during those occasional spikes and wipes out your position. You can hedge using options, try and time the market and buy in during an extended bull market (good luck), or size your position accordingly (less than 10% of your portfolio). Or YOLO the contents of your Roth IRA on it in the hopes of either making tendies or paying off your margin debt with blowjobs behind the Wendy's. I would describe this strategy as "picking up dollar bills in front of a bulldozer". You might make off with a good amount, and get away with it for a while, but sooner or later volatility and the irrationality of the market (and the panic of options traders underlining how the VIX is calculated) will fuck you.  The strategy does have the potential to deliver outsized gains over a short period of time. Most of the time (75% to 80%) the SVXY strategy is a real moneymaker—the rest of the time it is giving up a lot of value quickly and incurring a >80% loss will cause the ProShares to terminate the fund. THis simulation shows that 65%+ drawdowns would have occurred if the -0.5X SVXY had been trading in the 2004 to 2017 timeframe. The attached chart shows -0.5X SVXY from 2004 using historic VIX Futures values to generate simulated values.

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Shorting Volatility with SVYX: Because Risk Management is for Losers and Black Swans Do Not Exist

bullish

Apparantly I haven't learned jack shit from the "Volmageddon" event of February 5th, 2018 when the VIX (Wall Street's "oh fuck" meter) spiked over 100%+ and wiped out a handful of inverse volatility exchange traded products (RIP XIV), so here I am shorting volatility again. Stonks only go up, J-Pow and the Plunge Protection Team are here to save my bleeding portfolio.

Alright, so the genera idea is that shorting volatility proved to be very profitable historically. The stock market generally 1). trends upwards over time; and 2). volatility reverts to the mean. Because you can't buy the VIX directly, you have to rely on VIX futures. Because of factors 1 and 2, VIX futures drift lower over time, so all you have to do is being short a product that is long volatility (like VXX, dangerous because shorting exposes you to unlimited risk) or being long an inverse product (like SVXY, which caps your loss at how much you paid for your position).

The value of SVXY is set by the market, but it’s closely tied to the daily percentage moves of the inverse of an index (S&P VIX Short Term Futures) that manages a hypothetical portfolio containing VIX futures contracts with two different expirations. Every day the index methodology specifies a new mix of VIX futures in the portfolio. On a daily basis SVXY moves in the opposite direction of the index with a leverage factor of -0.5X, so for example, if the index moves up 0.3%, then SVXY will move down precisely 0.15%. Remember, the VIX usually trends downwards save for occasional market panics.

So what's the catch? Well, the issue with going short VXX (or better, being long SVXY) is those occasional big spikes, like the one in 2008, February 2018, and recently during the COVID crash of March 2020. SVXY went through some serious trauma in February 2018.  An unprecedented VIX spike and a VIX futures liquidity gap in the late afternoon of February 5th, 2018 resulted in a 90% drop in SVXY’s value and the XIV —a similar fund.  On February 27th, 2018, Proshares reduced the chances of a similar event in the future by lowering SVXY’s leverage from -1X the daily moves of SPVXSP, the VIX futures index it tracks, down to -0.5X.  This change reduces the chances of a similar drawdown, or of the fund terminating but also reduces the upside potential of SVXY. 

So the trick is to find a strategy that goes short VXX or long SVXY, but at the same time, doesn't lose much during those occasional spikes and wipes out your position. You can hedge using options, try and time the market and buy in during an extended bull market (good luck), or size your position accordingly (less than 10% of your portfolio). Or YOLO the contents of your Roth IRA on it in the hopes of either making tendies or paying off your margin debt with blowjobs behind the Wendy's. I would describe this strategy as "picking up dollar bills in front of a bulldozer". You might make off with a good amount, and get away with it for a while, but sooner or later volatility and the irrationality of the market (and the panic of options traders underlining how the VIX is calculated) will fuck you. 

The strategy does have the potential to deliver outsized gains over a short period of time. Most of the time (75% to 80%) the SVXY strategy is a real moneymaker—the rest of the time it is giving up a lot of value quickly and incurring a >80% loss will cause the ProShares to terminate the fund. THis simulation shows that 65%+ drawdowns would have occurred if the -0.5X SVXY had been trading in the 2004 to 2017 timeframe. The attached chart shows -0.5X SVXY from 2004 using historic VIX Futures values to generate simulated values.

 
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read-time
3 min

78.54

Target Price

8/ 10

Confidence

6-12 Months

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