^ ^^ Following on from above ...
How the inverse VIX became a swan dive
All very interesting, but a decade or so ago Wall Street's Masters of the Universe decided what
the VIX Index sorely lacked was a way to bet on it.
So the financial engineers invented the "inverse VIX", or XIV exchange traded products (ETPs), to bet on volatility.
Quite simply, if the VIX fell, the XIV would rise. For a long time it was a one-way bet.
A bit like the old Credit Default Swaps so popular before the GFC.
Indeed what could go wrong?
The market had gained 50 per cent in two years, sending VIX to historic lows as the S&P500 kept notching historic highs.
Even then, that was not enough.
Highly geared XIV ETPs were the next generation of weapons to accelerate returns by two or three times, depending on your
appetite for risk.
Once again, a bit like the old highly-geared Credit Default Swaps so popular before the GFC.
Of course, the highly-geared XIV products — and there were a number of them like the Credit Suisse backed VelocityShares XIV — would
double and treble losses if things came unstuck, which duly happened last week.
A bit like … well, a picture is beginning to emerge.
The VIX missed the warning signs and investors in XIV soon learnt a brutal lesson about one-way bets and complacency.
The market swooned, the VIX surged, the XIV plummeted. Losses were heading towards 90 per cent, while trading in the
biggest XIV ETPs were frozen. Nasty.
VIX vs XIV vs DJIA Bets that the VIX volatility index would stay low and Dow Jones wouldn't fall were painfully wrong for XIV investors
Even more nasty is the size of the problem.
On Bloomberg's analysis, funds ploughed in XIV products have gone from "zilch" a decade ago to $US1.5 trillion at the time of last week's "problems". Ouch.
While Wall Street's stumble is probably not much more than profit taking for traditional "long-only" equity investors, it is a lot more brutal for geared up XIV players.
Many are said to face being wiped out.
It is a case where the investment banks' marketing of "spreading the risk" is in fact "intensifying the the risk"."Quite why some thought already record low volatility would go even lower beats me and it all looks like another case of financial engineering
gone wrong, but as Warren Buffett has said, 'When the tide goes out you get to see who was swimming naked'," Dr Oliver said.
It may also be a factor in why the Australian ASX did not do its usual trick of falling harder and faster than Wall Street in times of distress.
Balance of the article
as Warren Buffett has said, 'When the tide goes out you get to see who was swimming naked'