Stocks quoted in this article:
Despite the impression that I gave yesterday, not everyone in the trading/investing world wants to go long volatility.
As Bloomberg notes, the picture for the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) has changed.
Short sellers are abandoning an exchange-traded fund that becomes more valuable during times of market tranquility after it soared 24 percent this year. Bearish bets on the fund, known as the VelocityShares Daily Inverse VIX (XIV) Short-Term ETN, make up 0.2 percent of outstanding shares, a record low, compared with 19 percent in June, according to data compiled by Markit Ltd.
This product makes everyone's head spin already, and doubly so when you start talking about shorting it, so let's unpack it a bit.
The iPath S&P 500 VIX Short-Term Futures ETN (VXX), as we know, proxies a 30-day rolling CBOE Volatility Index (VIX) future. It does terribly over the course of time, thanks to constantly having to roll out in time on an upwards-sloping VIX futures curve.
XIV inverse-tracks VXX. So, going long XIV is more or less equivalent to going short VXX. But, it's not identical. All trackers underperform when the basis product churns. So, even though VXX declines over pretty much any time frame, there's enough churn in there that an XIV long will modestly underperform a VXX short. The tradeoff is that any short has open-ended loss potential, whereas a long can only go to zero. If you're on the wrong side of a directional move, the XIV long will do better than the VXX short.
Now, let's take all that and look at it backwards. Shorting XIV is mostly similar but not identical to going long VXX. It will modestly outperform in a VXX churn, but with open-ended risk if VXX tanks. VXX is unlikely to abruptly tank ... VIX itself isn't going to abruptly tank from here, and VIX futures are extremely unlikely to give up all their premiums overnight. So, it's safe to say that shorting XIV is a better trade than going long VXX.
But, it's only better in the sense that it's less bad. They're both bad ideas. VXX will virtually always dribble lower over time, and XIV will always grind higher, albeit at a slower pace.
Shorting XIV is indeed a bet on a volatility lift -- so reduced interest in shorting this vehicle is an indication that there's less demand to bet on a volatility lift. Thus, on a contrarian basis, it's bullish for volatility and bearish for the market on the margins. I'd just like to emphasize, though, that it's really in the margins in this case. We're talking a reduction of a bet against a multi-tiered derivative. And, it's a play itself (shorting XIV) that will lose money over any longer time frame, so it's not shocking that the masses will not have much interest in it at times.
It is a data point against the argument that everyone wants to own volatility, I will give it that.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.