The Chicago Board of Options Exchange (Cboe) held a teleconference on Wednesday to address questions over the performance of certain derivative products linked to the Cboe Volatility Index (VIX).
While the stock market plunged, VIX— as would be expected— spiked by more than 80% on Tuesday, marking its biggest single-day increase since 1990. The sudden increase in VIX resulted in great losses to inverse VIX Exchanged Trade Funds (ETF) that profit from the opposite of the movements of the Volatility Index.
Two major players of shorting volatility strategies collapsed on Tuesday, raising fears across the market. Credit Suisse Group’s XIV (XIV) lost more than 90%. PraoShares’s SVXY (SVXY) also plummeted by more than 80%.
Following the sharp lose in the short-volatility funds, Goldman Sachs and JPMorgan changed their outlook on Cboe from buy to neutral due to risks associated with short-VIX strategies. As a result, Cboe’s stock price tumbled 17% on Tuesday (see chart).
In response to the sharp increase in market volatility over the past few days, Edward Tilly, chairman and Chief Executive Officer of Cboe, emphasized at the conference that “the products linked to volatility do not cause volatility.”
“A sudden and steep decline, such as the one that we experienced on Monday, will be punctuated with a sharp increase in the market volatility,” Tilly says. “However, VIX and VIX related ETPs continued to work as designed. Strategies and funds that incorporated volatility protection generally benefit while funds and strategies designed to short volatility suffered.”
Several professional investors on the call also raised concerns over the legitimacy of the exchange-traded funds (ETFs) or exchange-traded notes (ETNs) on VIX. Despite being leveraged and complex derivatives products, those ETPs that utilize futures and options contracts on VIX are sold on stock exchanges and easily available to retail investors. The sharp losses experienced by short volatility funds over the market crash led to questions about the extent of regulation that should be applied to such products.
That question would be better directed at the ETN issuer and the Securities and Exchange Commission. Cboe leaders made the point that the VIX acted as it was designed to.