On Feb 5 the VIX jumped nearly 120%, by far its largest one-day spike in history and enough to force the liquidation of XIV (VelocityShares Daily Inverse VIX), a $2B short VIX Futures ETN issued by Credit Suisse in 2010. Per XIV’s prospectus, to protect the firm’s balance sheet in an extreme VIX move the issuer reserves the right to redeem the note and return cash to shareholders. On Feb 5, Credit Suisse elected to take this option.
We’ve been preparing for this risk since we started Alpha Seeker over 6 years ago. Much like an options trader dealing with instruments that routinely go to zero, this risk is quantifiable and is explicitly incorporated in our positioning. This is one reason why net exposure in Alpha Seeker portfolios averaged less than 15% since the VIX broke below 20 in Jan 2016. At this exposure, even a completely unmanaged portfolio would lose 10-15% in a catastrophic event, a number in line with the catastrophic risk taken every day by equity investors. With our management, portfolios not only avoided but profited from the chaos on Feb 5. Over nearly 6 and a half years the strategy has performed similarly through many other volatility shocks including Brexit (Jun 2016), the Chinese devaluation episode (Aug 2015), the worst start to a year in S&P history (Jan 2016) and the historic turbulence around election night in November 2016.
Furthermore, well before February we had been very vocal on Twitter (@dynamicvol) and in various interviews (see below) about the need to understand and incorporate redemption risk in any VIX strategy. Starting in mid-January we are also on the record highlighting operational issues with XIV and on that basis switched to SVXY for short VIX positions while they were appropriate. While XIV is being wound down, SVXY will go on as before offering an identical exposure to XIV in a different legal format.
As of Feb 6, Alpha Seeker currently sits at an all-time high, profitable in February and for the year with an enormous opportunity (and the tools) to capitalize on further volatility in the short term, then mean reversion once conditions warrant. Going forward, we will continue to follow the strategy that has served us well in both calm and chaotic markets over the past 6 years and will continue to use VIX tools appropriately as conditions warrant.