Setting the right tone about the risk/reward relationship for VIX ETPs is a balancing act.
On one hand, I want overzealous readers, wowed by the big returns VIX trading offers, to understand that these products also carry significant potential risk, and should be relegated to an appropriate percentage of a portfolio. To these folks I say “keep calm”.
On the other hand, I want overly cautious readers to understand that losses that might be considered “big” in other investments (like yesterday’s -3.7% loss in XIV) are “business as usual”, the inherent cost of capturing those big returns. To these folks I also say “keep calm”.
To help set reasonable expectations for both types of readers, I’ve created the graph below showing the number of occurrences per year, since mid-2004, where 1-day gains/losses in XIV (inverse VIX, blue) and VXX (long VIX, red) have exceeded X%.
For example, 1-day losses exceeding XIV’s loss of -3.7% yesterday have occurred more than 24 times a year, or twice per month, on average. Business as usual.
Some quick notes:
- Really big gains or losses are not evenly spread out over the entire history. They tend to cluster. So for example, one probably shouldn’t expect a loss in XIV in excess of -6% every single month, just on average.
- This post is only looking at single-day losses. We’ll talk about more prolonged drawdowns as they rear their ugly heads in the future.
- We only have about a decade of data to consider, and these results may or may not match what we see over the next decade. It should go without saying (but I’ll say it anyways): past performance is never a guarantee of future results.
Click to see Volatility Made Simple’s own elegant solution to the VIX ETP puzzle.
Volatility Made Simple
Wonk note: data prior to the launch of XIV and VXX has been simulated. We’re able to do this accurately using a combination of the indices and the futures data on which these ETPs are based. Read more about simulating data for VIX ETPs.