Now, hats have been blown off by a whirlwind the likes of which Wall Street has never seen. Regulators are not at all inclined to take it, meaning the volatility complex will continue to grow, with the potential for real danger growing along with it.
The VIX moves from minute to minute with no idea where it will go from one moment to the next.
Those funds are inversely linked to the VIX, a gauge of turbulence in the market.
Now that all of these short-volatility naysayers have been proven right, the question becomes: what now?
This is, of course, the way finance has always worked.
As a result, the two popular inverse volatility products VelocityShares Inverse Vix Short-Term ETN XIV and ProShares Short VIX Short-Term Futures ETF SVXY tumbled 92.6% and 83%, respectively, in a single day on Tuesday's trading session. For the banks that made a market in these instruments, there was money to be made. And for more than a year, they couldn't lose.
The rise extended Tuesday's gains and followed volatile trading, triggered in part by concern over the prospect of higher interest rates. Barclays veteran Nick Cherney was a close follower when he founded VelocityShares.
It is not the first challenge for investors in a Credit Suisse ETN.
The fallout from the implosion of this vast array of arcane bets mounted quickly on Tuesday.
"With the CBOE SPX Volatility Index.VIX nearly tripling over the last three trading days mark-to-market profit and losses have been significant", said Ihor Dusaniwsky, head of research at S3 Partners. The index was started by the Chicago-based exchange. The bank also said that the XIV ETC activity is considerate of the market volatility of today and there Credit Suisse will not suffer any material impact. More recently, Societe Generale's head of global asset allocation, Alain Bokobza, compared the continued VIX shorting by hedge funds to "dancing on the rim of a volcano".
The trigger of these feedback loops is the constant rebalancing that exchange-traded notes like the XIV and the SVXY require.
Dusaniwsky said this could lead to higher volatility for XIV over the next few days as traders look to buy XIV to cover their short position.
A similar note issued by Nomura was also...
At this point, there's only one thing for sure: people are watching Golden.
You are not only gambling, then, if you hold this security, you are literally just handing all your money to the casino. Well, it is no different this time as Bloomberg says two tiny volatility products, which now only have $135m under management, were largely responsible for the selloff.
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