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Thursday, October 16, 2014

XIV and $VIX

Here's the thing:

Vix has gone up strongly. Also, the term structure is strongly inverted on the near end and flat further out.

So XIV holders get clobbered:

Because not only are they losing money inverse to the upward $VIX move, but they also lose money every night as roll-over of contracts happens because of the strong backwardation on the near end.

The problem I have, if I understand XIV right (and I'm not sure I do, so feel free to try and puzzle this out yourself), is that if Google Finance is right and XIV presently has over $800M in AUM, that would mean an entity in the market (this ETF) is essentially short the S&P 500 forward options' volatility premium to the tune of $800M, and the value of that short position has to move lower to save people's skins.

I don't know how much $800M is relative to the total value of the S&P 500 forward options' volatility premium. But if a rush for the exits in XIV happened, this would be a positive feedback on the volatility premium, and thus a positive feedback on $VIX, and thus a market with a XIV in it would move a little bit crazier than a market with no XIV in it.

I can't quantify any of this, but I just wanted to point out one small way in which this market has positive feedbacks that previous markets didn't.

In a cybernetic system, change one feedback and you change all sorts of behaviour.

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