You know when a single graph screams, and screaming tells you a lot of things?
Here, it is precisely the case of the following graph, relating to the trend of two investments on theVIX volatility index (two ETFs, among many listed on world stock exchanges), one long, i.e. positioned to gain in the event of a rise in the VIX, and the other shorts, which points instead to the descent.
Two investments diametrically opposed in their nature, but united in their outcome: disaster. Full throttle losses, just in case shorts, which has lost 86,5% (in euros) in the last twelve months, just in case long, which took home a loss of 73,2%. And all this while the VIX index gained a fat 167,5% (again in euros, even if the substance does not change in dollars).
Here are, in brief, some lessons an investor can learn from beatings like those taken by the VIX these days.
Bad author replies
The VIX is very useful for monitoring the temperature of the market (it is in fact a fundamental ingredient of our Risk Barometer). But as an investment, well, better leave it alone.
This is because a saver who invests in the VIX does so through ETFs or specialized funds that replicate the VIX. And the VIX's response is bad – the above numbers speak for themselves. One of the main reasons is that it is not simple, and the cost is often high, at the expense of performance.
I experienced it on my skin when in 2008, as a quantitative manager of alternative strategies, with the VIX well beyond the historical highs of the time, based on the signal of a model of statistical arbitrage, we went shorts of VIX Futures, with the idea that it could only go down. And so it happened, indeed. Except that instead of taking a few days to get down, it took him months. And in those months, the burden of "rolling" the expiring futures, replacing them with new ones, was devastating. I learned my lesson, and honestly, I don't want to hear about systematic strategies on the VIX ever since.
Negative feedback
The financial market is, from the point of view of mathematical structure, a highly interconnected complex system. This causes it to react like a black mamba: fast and deadly.
Specifically, when the VIX spikes, many of these (often leveraged) specialist VIX funds and ETFs are forced to buy VIX futures (thereby increasing demand and driving up the price), while simultaneously selling index futures. S&P500 (decreasing demand for it, and pushing it lower).
It's a bit technical, I know, but the result is that a vicious circle of rapid growth of the VIX and falling stock market values is triggered; the further it goes, the more it gains strength. But it doesn't end there. Almost all strategies trend following(e.g. those based on moving averages) trigger sales of the S&P 500 index. As well as protected investment strategies (e.g. CPPIs, Risk parity, those based on the Value-at-Risk, or constant volatility and company. The idea is that when risk increases, portfolios of risky assets are vacated, increasing their volatility and triggering further selling.
In short, there are quite a few pro-cyclical investment strategies out there that quickly track and amplify these sharp market movements.
Strategies crowded
Despite the drawbacks, the constant and striking decline in volatility in recent years, with the VIX down to 9,1%, a level so anomalous as to appear paradoxical, has stimulated volatility strategies. They have become very popular. Or, as they say in jargon, they are "crowded”, that is “crowded”.
And, just as happens when excessive crowds gather in small places, they have become unstable and dangerous: the air too full of something, panic around the corner. The performance of the stock exchanges these days is proof of this.
I hope it is clear to you that there are an infinite number of ways to commit financial suicide: well, large positions in various funds and ETFs long, shorts, ultra short o ultra long on the VIX they are an excellent way to end the life of your savings. Then, you see.
SOURCE: Advise Only
