The Best ETF of Our Time (AKA How to Become a Billionaire Without Really Try

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The Best ETF Of Our Time (AKA How To Become A Billionaire Without Really Trying) - ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) | Seeking Alpha

http://seekingalpha.com/article/1567282-the-best-etf-of-our-time-aka-how-to-become-a-billionaire-without-really-trying?page=2[1/5/2015 2:59:13 AM]

The Best ETF Of Our Time (AKA How To

Become A Billionaire Without Really Trying)

Macro Investor

Long only, macro

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Sometimes, a picture is indeed worth a thousand words.

(Click to enlarge)

SVXY Total Return Pricedata by YCharts

Ever since the financial crisis, investors has been asking for ways to hedge

market volatility. When there is demand there is supply, and a whole series of

Jul. 24, 2013 10:42 AM ET | 347 comments | About: ProShares Short VIX Short-Term Futures ETF (SVXY), Includes:

Disclosure: I am long XIV, SVXY.I also hold puts on VXX (More...)

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ETFs based on the volatility index (VIX) has come into being. With these ETFs

came the opportunity for investors to make incredible amounts of money. In

this article, I would like to discuss one that has the potential to make

billionaires. It is called the ProShares Short VIX Short-Term Futures ETF

(NYSEARCA:SVXY). There is a ETN incarnation of the same called the

VelocityShares Daily Inverse VIX Short-Term ETN(NASDAQ:XIV). While

I restrict this article to SVXY only, the same conclusions can be made about

XIV, as the underlying assets are identical for these two.

The above chart shows the performance of SVXY since inception. In less than

2 years, this ETF has grown close to 5x. Can it keep up this performance? To

examine that, let's first study how this ETF is constructed. This ETF is

designed to return, every day, the negative of the daily return of the most

popular volatility ETF, the iPath S&P 500 VIX Short-Term Futures ETN

(NYSEARCA:VXX). To model the SVXY, I started by modeling the VXX.

VXX invests in a combination of the two front month VIX futures. I had earlier

written in an article titled An ETF And An ETN That May Return 10-30% ByAugust Endthat explains how the VXX is constructed.

The VXX ETF ... keeps exposure of one month in the two front month

futures on the volatility index (VIX). It will invest in the combination

of the two forward month futures such that its weighted average

exposure is a month. This is how it works.

Today was the expiration of the July VIX futures, so as of end of day

today the VXX ETF is fully invested in the August futures. Over the

next 5 weeks it will sell a portion of its August futures every day and

buy September futures on VIX, to maintain the one month average

exposure. Since September futures are currently trading at around

7% higher than the August futures, each time it does this it will lose a

little bit of money, known as the roll yield (loss). In addition, the

August futures is currently about 12% higher than the spot VIX, so

that will erode as well, as it must match spot VIX on expiration.

For readers interested in knowing how this works out in practice, I

recommend this site.
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by Steven Hansen

Let's first model the VXX and in turn the SVXY in a situation where VIX is

unchanged. We can then add back the impact of a VIX change. Consider a 28

day VIX expiration cycle, where VIX starts at 19 (the historical average), and

remains unchanged every day. At the start of the cycle, the first month future

is modeled as 12% higher than VIX, and the second month future is modeled

8% higher than the first month future. (These are historical averages ever

since VIX futures started trading.) At the end of the cycle,the first month

future converges to the value of VIX, and the second month future is 12%

higher than VIX, as it is about to become the go forward first month future.

The model assumes that the VIX futures decay at a constant rate from start

to finish. This is how such a model would perform.

(Click to enlarge)

As the above chart shows, under this circumstance, VXX would decay by 9%,

and SVXY would increase by about 10%. (One interesting feature of this

model - the starting VIX price doesn't matter. You can plug in 10 or 30 and

the returns will still be identical to the one at 19.) If VIX remained unchanged

throughout the year (which is unlikely), this would result in a 200%+ annual

return for SVXY. Of course, in reality VIX would move around. So, I next

modeled the impact of a change in VIX.
http://static.cdn-seekingalpha.com/uploads/2013/7/22/5806521-13745454347352276-Macro-Investor_origin.png


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(Click to enlarge)

But what is a realistic monthly change in VIX? Next, I drew the distribution of

monthly VIX changes using data going back to 1990.

(Click to enlarge)

Clearly, there is a long tail. However, the 95% confidence intervals are -40%

to +43%. This means the 95% confidence interval for monthly change in

SVXY is roughly -25% to +80%. The average VIX monthly change is about

2%, so the average expected monthly change in SVXY is around 8% per my

model.

A expected monthly return of 8% is the stuff that makes not millions, but

billions. It translates to around 150% return for a year. A mere 10 bucks

invested at that rate of return would turn into a billion in about 20 years.

However, if only life were so easy. Note that there is a chance that SVXY

drops by up to 25% in a given month. A few months like that, and investors

would be facing extreme drawdowns, which are very difficult to recover from.

I decided to check what has happened in reality.

VIX futures started trading in 2004. Using data from CBOE, and using the

algorithm presented in the prospectus of the volatility ETFs, I created

synthetic values for SVXY going back to where the futures just startedtrading. Then, I measured annual return for each trading day, and averaged

that to get to average annual returns. Finally, I calculated maximum
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Conduct in-depth research on SVXY and 1,600+ other ETFs with SA's ETF Hub

drawdowns. Then I repeated the same but ignoring 2007-2009, the financial

crisis years, as these are (hopefully) an outlier that we will not again see in

decades. These are the results for simulated SVXY.

So, there you have it. In a rather turbulent period, SVXY has still returned, on

average, about 80% per year. In order to become a billionaire over the usual

30 years of investing life, an investor would have to put in 30 dollars into it in

a retirement account, and wake up a billionaire by the time of retirement.

This sounds way too easy, so what's the catch? Well, look at the max

drawdown figure. It is a whooping 90%. The investor would need an iron

stomach to weather that, and I believe most people would be unable to do

that. In fact, at about a 20% drawdown, I suspect people will be itching to

sell, and then buy back when the ETF rallies, thus eroding all the gains. For a

volatile ETF such as SVXY, people would for sure try to time the market, and

in the process lose all the gains. With great upside comes great drawdown, as

Spiderman would have said.

However, for those that have a strong stomach and a thousand dollars to

spare, I recommend putting in a thousand dollars in SVXY and put that in a

lockbox. Don't look at it for 20 years. I repeat, do not look at it, and ignore all

the market gyrations.

I suspect when you open the lockbox in 20 years you will be extremely happy.

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8/16



Volatility troubling to those who don't remember pre-QE markets Fri, Oct 10

The 'Fear Index' Vs. The 'Greed Index Mon, Aug 4

IEP 93.02 +0.55 +0.59

INO 9.32 +0.14 +1.53

IWM 118.93 -0. 69 -0. 58

JCP 6.29 -0. 19 -2. 93

JNJ 104.52 -0. 05 -0. 05

KO 42.14 -0. 08 -0. 19

LUMP 0.02 0.00 0.00

MNK 96.96 -2. 07 -2. 09

MSFT 46.76 +0.31 +0.67

NOK 8.01 +0.15 +1.91

NYX 45.18 -0. 61 -1. 33

OCAT 6.39 +0.30 +4.93

OIH 35.96 +0.04 +0.11

Comments(347) Track new comments

Great article! I have written about SVXY and XIV in the past and really like SVXY

because it has options. It is the perfect covered call choice for many of the

reasons you mentioned above.

I got crushed in XIV in 2011 when we had big extended volatility that crashed XIV

from 17 per share down to around 5, but I was smart enough to not sell. I held

because I too believed that once volatility returned to more normal levels, the

price would come back.

12 months later, the price was back around 17 and today it is up around 25!

Imagine those people who bought XIV at 5 just 24 months ago, and it is now

trading at 25! I would buy SVXY (because it has options) over XIV, and would buy

it any time volatility spikes. SVXY gains quickly in a volatility crush, as we just

saw a few weeks ago. 30 days ago, SVXY was trading around 72 and is today at

around 102...that is in 30 days! I made money on that volatility crush but played

it by selling a straddle on UVXY, a much riskier way to play it, but one that

worked out for me. Good luck to everyone!

24 Jul 2013, 10:59 AM ! Report Abuse ReplyLike 4

Comments (124) | + Follow | Send Message

David Oldenburg, Contributor

Yeah, I kind of prefer the way you employ some sort of hedging strategyover the lockbox idea.

That way you can devote larger amounts of money to the basic concepts

mentioned here, hopefully without having to stomach the 90% drawdowns

and still do very well.

24 Jul 2013, 02:21 PM ! Report Abuse ReplyLike 0


timex0

"12 months later, the price was back around 17 and today it is up around25! Imagine those people who bought XIV at 5 just 24 months ago, "


Freedoms Truth
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9/16



But this case shows why his analysis is over-optimistic and inaccurate.

XIV was 17 in July of 2011. Now it is 25. That's not "80% per year" not

even close. Not even better than the S&P.

XIV and SVXY are the same product. It gets killed when volatility spikes. It

also does not exactly track the way he thinks it does and aug 2011 is a

great example.

If you compare with vxx falling by 75% since july 2011, you'd think xiv

should be up 4x. It's not!

notice for example how xiv / svxy are YTD up about 40% while vxx hasfallen by more than half ... but if vxx DOUBLES what happens to xiv / svxy

? They crater by MORE than half... that 17 to 5 action was in tandem with

vxx doubling.

So, in other words, if we had a volatility even doubled vxx, to get it back to

where it was in january, xiv/svxy would end up at less than 25/2 or 12. So

you'd be BELOW the July 2011, and that just from an event that send vix

futures to around 30.

The article's critics in the comments are correct that his math is wrong and

its due to :

1) convexity - the difference between gains and losses on volatile products

tend to work in a way to DEGRADE returns.

2) volatility - adds risk while (again) reducing average returns.

(+50% and -50% gets you below even, so does +2% and -2%, which if

you do that daily, can grind down value. This is why the short version of

vxx and vxx together combined do worse than even.)

Its not a bad stock to own, I have some xiv in my IRA, but this article way

oversells its return and undersells the risks. It will not have the kind of

returns he claims unless there is a 30 year uninterrupted bull market.

wont happen.

The other criticism that he's not got 30 year of history is valid.

We have been in an unusual period of high volatility in a crisis and

postcrisis after shocks like in 2010, 2011 and 2012. that has created the

'perfect storm' of falling volatility while volatility futures have been in high

contango.

This have been a good time to be short volatility - if you skipped

2007/2008 so only since 2009 and only if you rode the crises ok. As usual

the early brave money gets the best returns. When this trade gets

crowded it will stop working, as contango premiums flatten just in time for

the next crisis to slaughter short vix positions.

http://seekingalpha.com/article/1567282-the-best-etf-of-our-time-aka-how-to-become-a-billionaire-without-really-trying#comment-21403382http://seekingalpha.com/article/1567282-the-best-etf-of-our-time-aka-how-to-become-a-billionaire-without-really-trying#comment-21403382


10/16



Authors reply Guys, I post a 10 year simulation, making clear there are

90% drawdowns, and you keep picking the periods of high drawdowns to

prove that I am wrong? Why am I not able to communicate what I mean

by long term?


Comments (9032) | Following | Send Message

Macro Investor, Contributor

MI:Guys, I post a 10 year simulation, making clear there are 90%

drawdowns, and you keep picking the periods of high drawdowns to prove

that I am wrong? Why am I not able to communicate what I mean by long

term?

S2L: Because buying and holding through a 94% drawdown (my

estimates) is financial hari-kiri.

Secondly and perhaps more importantly if one entertains the idea of buy

and hold with these instruments "no matter what".

You need to be prepared to go into the futures market yourself to execute

the strategy the best you can In the event of a financial crisis or

shuttering of the fund after huge losses (and outflows).

I say this because there is no guarantee the funds will be in existence

status post a huge drawdown.

It's one thing for your fund to lose 90+% and think you would hold on.

But what if you couldn't because the fund stopped trading?XIV explicitly states a 1 day 80% loss will be considered a termination

event for the etn.

The one day financial Armageddon of Oct 19 1987 in which the sp500 fell

in excess of 20% in one day would have certainly triggered such an event.

Furthermore Proshares on pg 140 of their prospectus states:

"Termination Events

The Trust, or, as the case may be, a Fund, may be dissolved at any time

and for any reason by the Sponsor

with written notice to the shareholders."



satan2liberals
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11/16



I'm with you there dude. You're suggesting a $1K investment that you

don't look at for 20 years. That's about 5 pizzas a year that you're giving

up, for a shot at potentially a boatload of money. Even with every qualifier

you could throw at it (past performance no guarantee of future

performance, structural issues with ETNs and ETFs (which also apply to

stuff like SPY), extreme drawdown risk, etc.), it's kind of silly not to give it

a try.

Another way to look at it, instead of buying a $1 lottery ticket once a week

for 20 years, you could put $1K in this, and you'd have a way, way higher

probability of making a boatload of money.



Andrew Fornes

Or you could see it as tossing away over $6K with a 10% annual return on

a different investment. Opportunity cost certainly exists, and it doesn'thave to be 5 pizzas per year.



Slick E

"XIV explicitly states a 1 day 80% loss will be considered a termination

event for the etn."

Wow. I didn't know that ... that makes its "go to zero" probability higher

than I thought.

When you consider that the vix jumped up 50% in feb 2007 - in a single

day and 'out of the blue' , or 1987 crash ... we know these things can

happen - becaseu they HAVE happened, but its impossible to assess the

probability of 6-sigma type events happening ing in the next 30 years/

7650 trading sessions.



Freedoms Truth

No, your whitewashing of Black Swan events is not why your annual

return conclusions are wrong, just suspect, because there is a large error


Freedoms Truth
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12/16



bar in even a long-term return assumption with those possibly sliced 90%

of the value of the position.

But, what make your return analysis wrong, its that:

a) xiv NEVER performs as well as the inverse of vxx

b) doing a monthly analysis leaves out the daily tracking error that you end

up getting and

c) which is largely responsible for that performance gap.

and

d) most importantly, others have done the more careful analysis based onhistorical daily returns, and it shows that xiv in a synthetic form would

have been at the equivalent of a little over $20 in feb 2007, before the

Chinese news event spiked vix and made it tumble. so barely 5%/yr in 6

years.

Based on the more careful analysis looking at actual daily returns, on Jan 1

2004, it was at an equivalent of $2. 10x to $22 in feb 2007, then in 2007

and 2008 fell by almost 90% to around $3. Today its at $26, so a 10x in a

decade. Respectable 30%/yr type returns but NOWHERE NEAR the

performance you claim, which is based not on history nor on the most

careful analysis, but more approximate analysis. You should not makesuch bold claims on the basis of approximate analysis. They are

overstated.

And yes, we are just one black swan event away from turning a 10x in 10

years into a 1x in 11years or so. Cant happen? If you say, but the whole

point of black swans are their inherent unpredictability.


Authors reply Once again you are not doing average annual return

calculation. You are doing point to point annualized return calculation.




"The one day financial Armageddon of Oct 19 1987 in which the sp500 fell

in excess of 20% in one day would have certainly triggered such anevent."

That won't happen anymore because there are circuit breakers put in that


idkmybffjill

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will freeze the markets from trading when a certain %-age threshold is

reached. I can assure you that threshold is much lower than a 20% loss.


Right, but the risk of getting less than 10% annual return over the course

of 20 years is pretty small with XIV.



Andrew Fornes

ID:"That won't happen anymore because there are circuit breakers put in

that will freeze the markets from trading when a certain %-age threshold

is reached."

S2L: Quite frankly with the advances in computerized orders since 1987

temporary halting the market may perversely increase selling pressure of

such a day.

How quickly does it take for a computer to go bid less and a stock trade

near zero now.

Does no one remember the flash crash in mere minutes the Dow lost 1000

points?



satan2liberals

"How quickly does it take for a computer to go bid less and a stock trade

near zero now."

Say what?



Santaku

Authors reply How much did vix futures spike on the day of the flash

crash?




Th B ETF Of O Ti (AKA H T B A Billi i Wi h R ll T i ) P Sh Sh VIX Sh T F ETF (NYSEARCA SVXY) | S ki Al h
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14/16



"The role of human market makers, who can match buyers and sellers and

provide liquidity to the market, is now more and more played by computer

programs. If those program traders pull back from the market, then big

"buy" or "sell" orders can lead to sudden, big swings. It increases the

probability of surprise distortions same as the equity markets, according

to a professional investor. In February 2011, the sugar market took a dive

of 6% in just one second. On March 1, Cocoa-futures prices dropped 13%in less than a minute on the IntercontinentalExchange. Cocoa plunged

$450 to a low of $3,217 a metric ton before rebounding quickly. The U.S.

dollar tumbled against the yen on March 16, falling 5% in minutes, one of

its biggest moves ever. According to a former cocoa trader: ' "The

electronic platform is too fast; it doesn't slow things down" like humans

would. '[59]"http://bit.ly/nUjrJa



satan2liberals

Authors reply But they recover just as fast. You seem to forget that S2L.

:-)

Look, I understand that you are very interested in second by second

trades, while I recommend 10-20 year buy and holds. Hence we are

always talking past each other.




Macro:Look, I understand that you are very interested in second by

second trades, while I recommend 10-20 year buy and holds. Hence we

are always talking past each other.

S2L: That's just nonsense Macro,I was just showing that computerized

trading increases the ability for more rapid market plunges.

Just because I recognize the " now is the best time to buy" mantra as

sheer nonsense doesn't make me a short term daytrader.

1 Aug 2013, 01:16

AM

! Report Abuse ReplyLike 0


satan2liberals


RedScourge

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I thought there were circuit breakers on SOME stocks, whereas this is is

not exactly a stock, although it IS exchange tradeable like a stock.

13 Aug 2013, 08:09 PM ! Report Abuse ReplyLike 0

Authors reply It's for the entire market.

http://bit.ly/qXPjvY

13 Aug 2013, 08:12 PM ! Report Abuse ReplyLike 1



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