Credit Suisse Fund Liquidated, ETFs Halted as Short-Vol Bets Die
bloomberg.com
bloomberg.com
The article's handwringing because their number might have included "novice retail investors" who didn't understand what they were buying, and only bought it because it's been a winning bet for a while.
If you don't fully understand a financial or investment product, you shouldn't buy it. Financial products involving words like "leveraged" or "options" or "cash-settled futures" are quite often more like bets than investments, and you should only trade them if you fully understand the product you're trading and are willing to accept that losing the bet may mean losing all the money you put in.
These instruments are a way to do fancy portfolio balancing, not bets and speculation. You'll need "real" leverage where you can come out in the negative instead of $0 to do that.
"Vol" means "volatility" which is a measure of how much the market moves over some interval of time. If the markets are getting more stable, it goes down, if markets are more choppy or have a higher varianceit goes up. Companies created funds, called ETFs or ETNs that let buyers bet on volatility. These funds are super easy to buy from any brokerage.
These funds were leveraged, which means they are based on bets against the underlying VIX index. This allowed them to move multiples of what the VIX moved, 2x or 3x as much.
The markets have been super calm so people were buying these funds that returned a lot of money if the market stayed calm. All of the sudden on Monday the market moved a LOT. The DOW dropped something like 1500 points and then bounced back 700 points within something like 15 minutes.
This caused the leveraged "short vol" funds - funds that were designed to move opposite multiples of the VIX (VIX moving not much made the value rise, VIX moving a lot made them fall) - to lose so much money so fast that the companies had to close them down. Billions of dollars lost in tens of minutes.
Hope that helps. I'm not an expert but that's how I understand it.
http://www.cmlviz.com/cmld3b/index.php?number=11930&app=news...
I guess the people who bought the EFTs and ETNs lost money because the funds' and notes'value plummeted, right?
But who won the money? I assume someone must have, since it doesn't seem to have stop existing.
A VIX future contract says Alice pays Bob cash up front for a contract, then Bob pays Alice cash on a specific date in the future based on the VIX value on that day, how much depends on a formula based on how low/high the VIX is.
The VIX itself is just a number calculated from recent S&P trading prices. The formula that determines how much Alice gets back in different scenarios is the main thing that makes different VIX futures contracts different. The formula can be "long," which means positive slope (higher VIX = Alice gets more) or "short" which means negative slope (higher VIX = Alice gets less). The formula can be "leveraged" which means slope greater than 1 (higher leverage = Alice gains or loses more per unit change in VIX).
Alice is called the "party" and Bob's called the "counterparty." A modern futures market has a small set of standardized contracts and a settlement / clearing system which allows anyone with a brokerage and enough money to act as a party or counterparty.
So the ETF basically takes investors' cash and buys a bunch of futures, which could all be from a bunch of different counterparties. The counterparties for the short futures have been losing money (paying more out at the end of each contract than they got at the beginning), which is where the money the ETF investors have been making up until now comes from (the numbers work out so that Bob was paying Alice more than Alice paid Bob). But this time the counterparties are making money (Bob pays Alice less at the end than Alice paid Bob at the beginning).
Because of leverage, in the worst case Alice could lose most or all of the money she put into the futures contract. Because this ETF's purpose is to put all of its investors' money into this futures contract, if you invested in this ETF you were making money before, but now you've lost nearly all of it.
For example, if you buy a futures contract with a value of $1000 but it only requires a 10% margin ($100) to buy the contract.. you are levered 10x if you only put $100 into the account. Let's say the futures contract drops 50% down to $500. You just lost $500 even though you put in $100. Someone gets that money on the other side. So there's an example of leverage that has nothing to do with money never existing.
Money that never existed is how you could talk about the vast majority of investments, but has nothing to really do with leverage. Let's say my company goes public and it's valued at $1,000,000. The share price is $100. Well people keep buying and selling higher and higher, now the share price is $200. Then $300. Everyone now holding the shares at $300 has the company valued at $3,000,000 and claims they collectively "have" $3,000,000 of value.. but.. nothing changed. My company has done nothing different. This is money that never existed in the first place.
If the volatility moves from 15 -> 30, it goes up 100%. What happens if you are "short" (or on the opposite side) of something going up 100%? It loses it's entire value.
Now of course it's more complicated, and if the movement from 15->30 happens over a long period of time you can be modifying the hedges to work it out so you don't go to 0.. but if the price SUDDENLY goes up 100% with very little time to react, and you hit all your margin calls on various hedges.. then it's dead.