Wall Street types oftentimes chide bitcoin as being far too risky for their investment tastes. But some of these investors have their own rush of choice — Short Volatility ETNs. And these ETNs are so volatile, in fact, that murmurs are growing they could cause a stock market crash.
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Welcome to the VIX Index
In mainstream circles, bitcoin is most commonly associated with financial risk. But when it comes to the traditional world of finance, there are assets that are, in fact, even riskier.
Many Bitcoiners first came to this realization during the recent U.S. Senate hearing on cryptocurrencies, wherein new darling of the cryptoverse and Commodities Futures Trading Commission (CFTC) Chairman Christopher Giancarlo highlighted the VIX index:
“Bitcoin’s volatility was not as large as other asset classes like VIX. We have seen extreme volatility in bitcoin but in our world, we are used to volatility in asset classes.”
Giancarlo sounds cool and collected here, but when he suggests the VIX index is volatile, he ain’t kidding.
The VIX and Short Volatility ETNs
This is the world of futures contracts, and CBOE is the king of futures, so the VIX is officially the CBOE Market Volatility Index. It’s also popularly — and ominously — known as Wall Street’s “Fear Index.”
Accordingly, the VIX tracks volatility within the powerhouse S&P 500. And, while it’s only a statistic and can’t be traded itself, the VIX has numerous exchange-traded notes that are tagged to it.
These notes are Short Volatility ETNs like ZIV, XIV, XXV, SVXY, EXIV, and VMIN. They’re futures contracts allowing investors to speculate on how the CBOE Market Volatility Index will perform. And, like bitcoin futures contracts, these ETNs close on given days.
The problem? These ETNs could be prone to a mass liquidation event. And you know what comes after that …
A Potential Stock Market Crash
Those who purchase ETNs based on the VIX are essentially going long on market volatility. When the VIX gains 50 percent, traders who went long on volatility swing up 50 percent too. In that scenario, traders shorting volatility see 50 percent losses in kind.
So what happens if ETNs get rekt, as the “crypto kids” call it?
Issuers of ETNs will typically begin mass liquidation when losses reach up between 80 and 100 percent. Such a mass liquidation could trigger shockwaves and further liquidations, and the stock market would certainly suffer.
Scarily enough, the XIV ETN saw a 86 percent plummet on February 2nd, which sunk to 97 percent by February 5th, so the conditions were there for a liquidation event to begin. And sell pressure in the futures market can bleed into the stock market.
So we don’t know what will happen. But any time someone says bitcoin is too risky for their tastes, remind them that investors play with Short Volatility ETNs every day. The end result may be disastrous.
What do you think? Had you ever heard of the VIX before? Sound off in the comments below.
Images via BigTrends, The Nation