Schaeffer's Trading Floor Blog

Why Bother With XIV?

Volume is increasing on the VelocityShares Daily Inverse XIV Short-Term ETN (XIV)

by 8/26/2014 9:37 AM
Stocks quoted in this article:

In focus: 200 on SPDR S&P 500 ETF Trust (SPY) and 2,000 on S&P 500 Index (SPX)!

It's party time, and everyone wants to celebrate, including volatility sellers. As Bloomberg noted last week, VelocityShares Daily Inverse VIX Short Term ETN (XIV) volume is increasing. That's, of course, more or less the same thing as shorting iPath S&P 500 VIX Short-Term Futures ETN (VXX). But fear not, shorting VXX is staying trendy, too:

Volatility in U.S. equity markets is near an all-time low, and because traders have loaded up on bets, it has farther to fall.

Short holdings on an exchange-traded note tracking the Chicago Board Options Exchange Volatility Index (VIX) reached a six-month high in August, essentially a bet that the volatility gauge will keep falling. There are about 19 million shares of the iPath S&P 500 VIX Short-Term Futures ETN (VXX) that have been borrowed and sold to speculation on declines, almost three times the level from early June, data compiled by Markit Ltd. shows.

The iPath ETN, often known by its ticker VXX, has become one of the most-traded U.S. securities as strategies based on volatility exploded in popularity. A daily average of 42.8 million shares changed hands over the past month, third only to the SPDR S&P 500 ETF Trust (SPY) and iShares MSCI Emerging Markets (ETF) exchange-traded funds, according to data compiled by Bloomberg.

Now, even though XIV is literally an inverse play on VXX, buying XIV is not exactly like shorting VXX. Generally speaking, shorting VXX is a better play.

That's because XIV is a tracker and subject to the same laws of compounding as every other tracker. If VXX churns, then XIV will gradually drift.

For example, VXX hit its last all-time low of 26.95 on July 3 and closed at 27.17, about where it trades now. XIV closed at 47.27 the same day and is now about 5% below that. So in about seven weeks of churn, XIV has lost 5% of its "value" relative to VXX.

So why ever bother with XIV? Well, it does have a couple potential advantages. One is that VXX can become hard to borrow, though it's not that way right now. If it does become difficult, you'd have to pay interest on your short which would eat into some of the advantage over XIV.

The other is that it's less risky to be long something than short it. The upside is theoretically open-ended in VXX vs. defined in XIV. Shorting VXX is de facto going short gamma on your portfolio. If/when volatility lifts, the "value" of your volatility short is increasing. Conversely, the "value" of an XIV long is decreasing. If the position is wrong, an XIV works less badly than a VXX short.

For those that can't short anyway, it's a moot point; you can't use VXX unless you want to buy it. And you should never want to buy it; use regular puts instead.

For what it's worth, I'd rather only short VXX or go long XIV as a fade against a VIX pop. Not saying it won't work now; it probably will. Just that it's not for me at this time.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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