Starting on Friday, February 2, and continuing on the following Monday, global equity markets sustained their largest correction in more than two years. While small in historical context, this correction was a rude awakening for many investors who had grown comfortable with the unusual stability in the stock market throughout 2017. Some investors did more than just grow comfortable, they started betting on this stability to continue, in the form of shorting volatility. These bets, which essentially profit when the market stays calm, can sustain very large losses when volatility returns. The trades are complex, but when packaged into a convenient exchange-traded product (ETN), traders may fail to understand the risks being taken.
Such was the case for traders utilizing the Credit Suisse Velocity Shares Daily Inverse VIX Short-Term ETN (say that three times fast), who saw the product collapse as a result of the strong volatility late in Monday’s trading session. As a result, investors realized losses of just over 80% by Tuesday morning, as Credit Suisse worked to close out its positions and return what’s left of investor principal. Tuesday, in an interview with an inventor of Wall Street’s ‘fear index’, the VIX, Devesh Shah went so far as to say, “In my wildest imagination I don’t know why these products exist. Who do they benefit? No one, except if someone wants to gamble –then, OK, just go gamble.” The experience of this ETN provides us with another example of how unique investments that suddenly have stellar performance are likely to be betting on a unique risk factor which is unlikely to persist over the long term.