Reposted Thoughts on Short Vol Implosion

I inadvertently deleted my last post on 10 lessons we can learn from this latest round of exploding vol and the implosion of short vol strategies and products. With everything going on in markets right now, I have to focus on other things and let that post go. I still have the images, so I can give a brief recap of those at least!

  1. AVOID shorting volatile assets and NEVER EVER short something that can spike up exponentially. It doesn’t matter how smart you are because you don’t know the future. History is littered with smart people that blew themselves up by shorting imprudently.
  2. Looking at the below chart, it’s difficult for me to understand how anyone could short the VIX in January. You’re getting a low price on your short sale and it frequently explodes higher. 
  3. Unfortunately there’s a lot of perverse incentives and other bullshit in financial services. Sponsors and managers are incented to create products to generate management fees, brokers and custodians encourage trading to generate transaction fees, and it nobody cares if the products are beneficial or not. Some of them are dangerous. Below is the VelocityShares Daily Inverse VIX Short Term ETN (symbol: XIV). Went down 90+% overnight. Investors lost money, while the product sponsor, manager, and brokerages all made money and didn’t lose it when the thing crashed.
  4. It’s not just retail investors that make mistakes though. Recently, a bunch of Wells Fargo advisors were fined for not understanding the above types of funds and making misguided  recommendations to clients. Another team that manages a hedge fund and a public mutual fund (symbol LJMIX) made some serious errors causing their mutual fund investors to lose 80+%. This is a publicly-registered mutual fund with the word preservation in it’s name. Buyer beware indeed! Knowing what you own is much more important than knowing it’s history. The magnitude of adversity often trumps the probability of adversity.

This is not an “I told you so” post. The lesson is that investing is tough, so implement some risk management as guardrails and be discerning and skeptical. Retail and professional investors alike are susceptible to greed and complacency.

Have a great weekend and back up your blogs!

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Disclosures & Disclaimers page for a full disclaimer.