Is Fat Passive Income From VIX Dead Forever?

Summary:
The stock price falls in February caused an Armageddon in the group of volatility short products. One volatility ETN is closed, but the others are gaining again. High reward possible, but with very high risk.

This week has bought new volatility to the stock markets, mostly with the Italian political uncertainty in focus. Yesterday, the 29th of may, near term VIX index future was up by about 12 percent, shaking VIX ETN prices – again.

In February, volatility exploded, after a very quiet 2017. Billions of dollars were invested in last years in volatility ETN-s (Exchange Traded Notes), certificates and other instruments. In most part of the time, shorting VIX (the volatility index of the S&P 500 index) gives you a solid high yield passive income, but you must deal with very high risk. Some years volatility spikes and makes short positions quickly worthless.

(For beginners: This income is caused by the high contango, it means, the difference between the prices of the several futures. Contango is when futures prices are higher with the time, backwardation is the opposite case. With this, you gain on “rolling”: you rebuild your positions every month on a higher price on the new near term futures. That gives you an interest-like, regular income by shorting – if prices stay in contango.)

This income, depending on the state of this contango and the several fees, can reach 2-4 percent – monthly. For example, in 2017, in one year, VIX shorting ETN-s (XIV, ZIV, SVXY or XIVH) gained 80-190 percent, in only one year. (See table.)

But most part of the fantastic incomes from the last years was lost forever in a couple of days in February as VIX jumped to 50,3 and VIX Futures to 33,35. This was a “VIX shorting Armageddon”, as somebody wrote earlier. The short ETN-s in this sector lost differently, in the worst case of XIV it was a really painfull Death Cross: about 95 percent of stock price was gone.

The XIV, probably the best known VIX shorting instrument, was liquitated the same month. But the other ETN-s, after several weeks of suffering, began gaining again, because the VIX market returned to the usual contango state.

And now? Can return the volatility of the 8th of February, and destroy again 60-80-100 percent of value of VIX shorting instruments? Of course. This is always possible, unexpected political events, sudden stock market corrections, surprising macroeconomic data or “black swans” can make volatility skyrocket again. The Italian uncertainty can last months or almost a year, new elections are coming, but probably only in autumn or the beginning of next year.

This year seems to be more volatile on the markets, so “go short and enjoy passive incomes” VIX strategy may be not so promising as in the last several years. But it is also possible if contango stays on the market and VIX doesn’t spike too high. This can be also the year of a more complicated strategy, with a more active volatility portfolio management and very careful diversification, risk management. As you see loss of 100 percent is also possible in a single day.

Next time I ‘d like to take a look on the differences between the strategies some of the volatility ETN-s.

Disclaimer:
I am not a financial advisor and this content in this article is not a financial or investment advice. It is for informative purposes only. Consult your advisers before making any decision.