Muir: "People Are Going To Be Wiped Out" By Short-VIX ETFs

Back in August, we highlighted a story in the New York Times about a former manager at Target who decided to try day trading with $500,000 he had saved up. Over the following years, he turned that into $13 million by following one simple strategy: Shorting volatility every time it spiked.

As MacroVoices host Erik Townsend points out, that strategy has worked for many retail investors over the past eight years. And in a brief “postgame” interview with the Macro Tourist Kevin Muir following a longer interview with Francesco Filia, a fund manager at Fasanara Capital, the former explains how many investors don’t understand the risks associated with shorting volatility, as well as the possible repercussions if exchanges and brokerages don’t take the appropriate steps to limit this.

Townsend begins the discussion by asking Muir about a chart he created of the VXX - the long-VIX ETF - which, because of the low-volatility environement, has repeatedly split leading to unbelievable wealth destruction.

Going back to 2009, the price of the ETF has gone from $120,000 a share to just $35. And while a sudden spike in volatility could see it surge, with so many investors on the other side of the trade, it's worth considering what might happen if they couldn't pay.

It’s frightening. And I don’t think enough people are – well, there are some – but I don’t think that enough people are really considering all these things. And I think that guys like the Interactive Broker chairman, that are taking proactive steps to make sure that there’s enough margin, we need to see more of that. We need to see more people saying, hey, wait, this is actually a very, very scary instrument that has a lot of risk in it.


I watched a Real Vision interview with John Hempton from Bronte Capital, and he talked about phoning up the infamous Target salesman guy, the fellow that quit his job as a Target manager to trade XIV and all the VXX products, and he turned his 1/2 a million bucks into 13 million bucks. The part that really scared me about it was that John phoned him up and he was expecting to talk to this very sophisticated guy, and his basic takeaway was that, although he had a lot of buzzwords, and he understood kind of what the products represented, he didn’t really understand his true risk.


And I think that there’s just a myriad of people out there that are trading these things that don’t understand that. The more people that wake up and realize this, and stop playing this game, the better off we’ll be, actually.

Brokerages have caught on to this, Muir says. Interactive Brokers, one of the largest online brokerages, is now asking retail investors to post between 300%-400% margin when they short certain VIX contracts – because brokerages recognize that one sharp drawdown in the S&P 500 could blow millions of short traders out of their positions, potentially leaving thousands of customers with massive negative balances that could threaten the brokerages’ existence.

Erik, you’re absolutely correct. And Interactive Brokers, one of the largest electronic brokers out there, realizes the risk. If you look at the way that they’re margining these products, they’re margining them completely different than what the exchanges and everyone else say is the proper amount.


So if you look at the VIX futures, the front month is $6,200 – the exchange minimum is $6,200 – which works out to roughly 50% of a contract. The next month is $4,000, which works out to 30% of a contract. And the far months are $2,500, which works out to 17% of a contract.


But if you go to Interactive Brokers and you want to sell this VIX contract short, you have to put up 300%–400% of the contract. Because they’ve looked at it and they’ve realized that if the S&P has a 10% down move, which isn’t out of the realm of possibility, that the VIX could spike up to 37 really easily. And people are going to be wiped out if that happens.

Should the VIX suddenly spike, the repercussions of such a move would be further complicated by the billions of dollars sitting in various VIX-linked ETFs. Because individuals sellers would probably disappear from the market in such a situation, the ETF market makers would find it nearly impossible to hedge their positions, potentially triggering the dissolution of the funds, or even the collapse of some of these firms.

There’s $1.2 billion of the XIV, which is the short ETF. There’s $1.3 billion of the SVXY, which is another short one. These are staggering numbers.


In my days, when I was on the institutional desk, we had this big – I did index arbitrage, and we used to go out and buy the baskets and sell the futures. One day the risk manager came to me and said, if you had to take this position off (because we had accumulated this big position) how long would it take you? And who would do it?


And I said, the reality is that there’s nobody. You know, we were the biggest player in the market and there was nobody that was going to take this off of us. The only way was to go all the way to expiry.


Well, the reality is that these numbers are way bigger than any market player can absorb. And, if we get a situation where – as Francesco says, all it’s going to take is a return of the VIX from its current level of 10 to its average level of 18 or 19 to wipe out these products.


I guess that’s the point that I want to make: If you’re actually owning these things, you should be aware that all it will take is a move of 80% and then they’re going to wind down these products. So the XIV, when it moves up, if all of a sudden VIX goes from 10 to 18 in a day, they’re going to wind down that product.


And what’s going to be really scary is the amount of VIX futures that is going to have to be bought, because they’re short all those VIX futures and they’re going to have to buy them back.


And I just don’t know who’s going to sell it to them. For the first time – for a long time, I didn’t view this VIX as that big a deal, and there were some smart guys like Jesse Felder that were going on about it – I just think that it has been taken to a level that is becoming increasingly worrisome. And it actually could create a market dislocation in itself.


And what is it Warren Buffett says? What the wise man does in the beginning the fool does in the end. Well, VIX, at this point, we’re hitting a point where if you’re actually continuing to bet on it you’re going to be in the fool category.


Because it’s not going to take much to have a big spike that wipes a lot of people out. And it’s actually very, very worrisome.

Of course, it would take a large intraday move to trigger a truly catastrophic spike in the VIX. But at least one analyst, Bank of America’s Michael Hartnett – whose work we have cited here – believes there could be a 1987-style crash in the early months of 2018. Hartnett’s reasoning? The bearish positioning seen at the beginning of 2017 has completely flipped. Investors’ long positions are larger than they’ve been in years.

And as we’ve repeatedly pointed out, with volatility and volume so subdued, hedge funds have remained overwhelmingly short vol, fearful of missing out on even one tick of the torrid rally for fear of pissing off their clients.

One things for certain: Given the market’s already dramatically overextended rally, the day of reckoning is coming. The only question is will it be a steady decline, or will it happen suddenly?

Given the incredibly stretched nature of positioning, the latter scenario, Muir and Co. believe, seems far more likely.

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Muir's discussion begins just after the hour mark:



GUS100CORRINA MonetaryApostate Sun, 11/26/2017 - 03:10 Permalink

Muir: "People Are Going To Be Wiped Out" By Short-VIX ETFsMy response: I absolutely believe the article title every time I see the following chart. This whole VIX situation reminds me of LTCM on steroids where the Central Banks are the enablers of LTCM-type firms and situations everywhere.ProShares Short VIX Short-Term Futures:

In reply to by MonetaryApostate

zebra77a Buck Johnson Sun, 11/26/2017 - 13:29 Permalink

Firstly the counter-party to all option contracts by both buyer's and sellers -  is not the public it's the Options Clearning Corporation.Who has it's own in-house pricing model for VIX. - settting it in the perfect sweet spot to burn both shorts and longs in the perfect log middle.And set's it to anything they like, thus everyone going short means they will spike it long under the Maximum Pain mantra..That is why you would see repeated double - tops, as the shorts would come bailing in on a VIX spike the OCC would hammer it higher one more time, past introspection has shown them spiking it up to a dozen times to shake out any incoming shorts.  

In reply to by Buck Johnson

Xena fobe max2205 Sat, 11/25/2017 - 20:43 Permalink

Ouch.  I've had mixed results.  VIX is lopsided.  Decay on long VIX is fast even in down markets.  The last time VIX spiked was Brexit.  I caught part of that spike. Then lost it back.  I am too risk averse to hold anything anyway. Hope the short VIX positions don't destroy all these products.   They are useful. 

In reply to by max2205

Spectre Sat, 11/25/2017 - 20:19 Permalink

When the greedy fingers of Wall Street get a hold of the Crypto markets, it will be painful, BTC leasing, rehypothicating , naked shorting all the usual plays,  Hell, their will be a VIX for volatility in Crypto's.  Then BAM

TrustbutVerify Sat, 11/25/2017 - 20:38 Permalink

The short VIX position is a bet on worldwide QE4 style bailouts.  Will central banks really allow the STHTF and not to anything?  There will be some level of bailout.  There has to be.  

TrustbutVerify indygo55 Sun, 11/26/2017 - 11:27 Permalink

What do you think the previous QE bail-outs were made with?  Nothing but printing press dollars (and phony low non-market interest rates).  I agree about the value of the dollar, at some point, tanking.  I remember Marc Faber some years ago using the term, "QE forever."  The idea correlates with the recent period of extremely low Vix numers.  It might also explain present bets, too.  The implication is the Fed is just not going to allow a crash to occur.  But its just an impliction.  Though increasingly burgeining debt figures combined with future unfundable entitlement promises might lead the Fed to keeo the boat floating instead of allowing a crash.  A recession/depression would be devastating to government tax receipts.  

In reply to by indygo55

USofAzzDownWeGo Sat, 11/25/2017 - 20:45 Permalink

what a bunch if nonsene rambling... you buy puts on vxx any time t pops. the fed uses these to short the vix which props up the market.. these are fed tools... they aren't going anywhere

OverTheHedge P Christmas Carole Sun, 11/26/2017 - 08:24 Permalink

Well, here's a thing. If you have to have multiple accounts on ZeroHedge to try to talk up your sad little website, it obviously isn't as good as you say it is. If Shepwave were all it is making itself out to be, firstly it would be TOP SECRET! Secondly, Mr Shep and his handkerchief would be gazillionaires, so wouldn't need to trade any more, let alone shop for sad-sack wannabes who will sign up for the weekly newsletter or whatever it might be that you are flogging.Your very presence here signifies how useless your product MUST be. Sorry.

In reply to by P Christmas Carole

HRH of Aquitaine 2.0 Sat, 11/25/2017 - 21:37 Permalink

The lack of fear is disturbing.

I have been watching BTC for the past 15 hours. It's crazy. Anyone that doesn't think this is all a huge bubble, including BTC, is an idiot. I went to cash a few days ago so I am sitting on the sidelines watching. If you aren't nervous about everything you aren't paying attention.

The only thing that doesn't make me nervous, in fact, is silver. Rock steady. Same old price and under $20 for .9999 bullion coins. That is also crazy.

I am done with crazy town. I need a ride outa here! Fast!

Advoc8tr HRH of Aquitaine 2.0 Sat, 11/25/2017 - 22:18 Permalink

The whole world piling into 16 million Bitcoins easily accounts for the genuine rapid growth ... still only about 2% worldwide awareness so expect it it to ramp up not down.  You are comparing apples to oranges. A bubble implies stretching fundamentals.  Even if just the market cap of Gold bullion moves into BTC it will be $500K per coin ... start talking about a percentage of stock market, M2, derivatives and the sky is literally the limit.

In reply to by HRH of Aquitaine 2.0

Miggy Sat, 11/25/2017 - 22:09 Permalink

So the guy doesn't speak real well but he made the market say uncle. I like the guy.Oh the horror of the regular Joe making money from the market. We need to stop that and fast.

HelloSpencer Sat, 11/25/2017 - 22:22 Permalink

Cannot wait to see the VIX short-sellers be obliterated. August 25, 2015 will look like a walk in the part compared to what is coming at some point. When? Who knows. But it is coming. ETFs/ETNs like XIV and SVXY will go to zero (ideally, overnight :)).Just take a look at what is going on since Feb 2016. It is insane. There are correlations that have no business being positive and they did turn positive.

Herdee Sat, 11/25/2017 - 22:38 Permalink

Problem is that the Longs plus the Exchanges could be wiped out in a sudden move as well. Counterparty risk involves margin on both sides of the coin. If it's not there on the short side of Volatility, both sides can get wiped out, not just one. You want to sell or buy, you can't get out. There has to be a counterparty in a trade. Most don't understand the danger coming up in December. The Market has priced in a 100% chance of a rate hike. Here's Jim Rickard's opinion on what's coming up so watch your money on this one. It could be a big turn around?  

JLM Sat, 11/25/2017 - 23:15 Permalink

No wonder he made so much money.  There is no risk in a rigged game.  Wash rinse repeat.  Just make sure you are reading things correctly.  If anyone ever wanted proof the markets are rigged this is it.  This could never happen in real markets.