Collecting Social Security spousal benefits even if your spouse is gone

Dr. Fauci: ‘We may be able to put this coronavirus outbreak behind us’ — but he says Americans must play a critical role

Stock market is at the start of a selloff, says veteran trader Larry Williams

Fed’s Kashkari decries ‘absurd’ U.S. financial system that needs bailout every 10 years

Market Extra

‘Short-volatility Armageddon’ craters a pair of Wall Street’s most popular trades, could roil market

Exchange-traded products XIV and SVXY are halted in premarket trade on Tuesday after tumbling in value in after-hours trade Monday

One of the most popular trades in the market, betting a period of unnatural calm would continue, may have amplified selling pressure in the stock market on Monday market participants said.

At least two products tied to volatility bets were severely whacked with the hemorrhaging that could pose challenges to the exchange-traded notes.

One popular product, the VelocityShares Daily Inverse VIX Short Term ETN XIV was down 90% in after-hours trade on Monday, following a session in which the Dow Jones Industrial DJIA-0.88% plunged by 1,175 points, or 4.6%, while the S&P 500 index SPX-1.12% tumbled 4.1%—both benchmarks coughed up all of their gains for 2018.

The Cboe Volatility Index VIX-2.38% meanwhile, skyrocketed by about 118%, marking its sharpest daily rise on record. The VIX uses bullish and bearish option bets on the S&P 500 to reflect expected volatility over the coming 30 days, and it typically rises as stocks fall.

The XIV, meanwhile, was designed to allow investors to bet against a rise in volatility and such bets had been a winning proposition until recently, when equities accelerated a multisession unraveling fueled by fears that the Federal Reserve will be forced to raise borrowing costs faster than anticipated due to a potential resurgence in inflation, which had pushed Treasury yields higher.

Monday’s stock-market drop may have been amplified because those making bets that volatility, as measured by the VIX, would remain relatively subdued, were caught wrong-footed.

As a result, XIV funds and VIX-pegged products which offer leveraged short bets, including another known as the ProShares Short VIX Short-Term Futures ETF SVXY+0.06% which rebalance their underlying funds daily, will be forced to do so at elevated levels given the dramatic jump in the VIX.

Both the XIV and the SVXY as they are commonly referred among traders were halted in premarket trade on Tuesday, with investors questioning whether they will be liquidated.

Shorting refers to a bet that an asset will fall in value, with traders making a profit from the difference of that asset when it is returned. But when a surge in price occurs it can translate into extreme pain since an asset’s price can rise infinitely, while a declining asset can only go to zero.

Here’s how market strategist Larry McDonald explained the XIV move in a Monday blog post titled “Short-volatility Armageddon’:

This $200M vega creating $37B in demand for short term VIX was based on a 45% spike. Today VIX closed up 89.77%. The forced buying therefore could be much, much bigger.

In options trading, vega refers to how sensitive an option’s price is to the volatility of the underlying security.

McDonald notes that in a world of ultralow volatility, investors have been crowding into bearish volatility trades:

In the present environment of low volatility and low yield, many investors have reached out to yield enhancing strategies by selling volatility. When yields are low, investors sell volatility to generate extra income. The supply of yield seeking risk premia strategies has grown by $1bl vega in recent months, equal to 30% of S&P options market.

Products like XIV also may see further selling because they are designed to unwind when the they hit certain thresholds. For example, according to exchange-traded note XIV’s prospectus (see pg. PS-28), “if the price of the underlying futures contracts decreases by more than 80% in a day, it is extremely likely that the long ETNs will depreciate to an intraday indicative value or closing indicative value equal to or less than 20% of the prior day’s closing indicative value and will be subject to acceleration if we choose to exercise our right to effect an Event Acceleration of the ETNs.”

“Moves in the VIX had XIV scrambling to cover,” said Mark Longo, CEO of Chicago-based research firm TheOptionsInsider.com.

A spokeswoman at Credit Suisse, XIV’s issuer, was unable to comment on the volatility product to MarketWatch, but in a statement the bank said it had “experienced no trading losses from Velocity Shares.”

ProShares which issues SVXY couldn’t be reached for comment.

“When you have these levered products, these frankenproducts, when it hits the fan, that’s when this kind of stuff gets wiped off the map,” Longo said., referring to leveraged VIX ETPs.

Moves in both the XIV and ProShares’s SVXY were fueling speculation that they could both face unwinds in the coming session.

According to The Wall Street Journal, citing analysts, if those volatility products go away it could “ripple throughout the volatility world, potentially causing severe losses for investors and magnifying moves in the VIX futures market.

See original version of this story