How SVXY works

SVXY (ProShares Short VIX Short-Term Futures ETF) is one of the more intuitive ways to make directional calls on volatility or the VIX.

For most part, it moves up when volatility is tame or decreasing, so it can be thought of as investing in market calmness. It crashes when there are market panics. If you think that sounds a lot like the stock market, you are right. SVXY is highly correlated to stocks (S&P 500 to be precise), yet somewhat different.

Skip to the end if you just wish to trade it without the boring details.

short facts:

 

It aims to track the inverse (-1x) of the S&P 500 VIX Short-Term Futures Index by holding VIX futures in its portfolio and adjusting it such that the weighted average time to expiry of the futures is one month. You can see the holdings here.

It is meant to provide -1x the single-day return of the index (not the VIX!) - longer holding periods will deviate from index returns due to daily rebalancing. According to its fact sheet, it has done very well in mimicking the -1x move of the index.

It will not track the VIX very well - mainly due to the fact that VIX futures do not track the VIX well. It averages -0.46x the daily price change of the VIX (data from Oct-2011 to Aug-2017).

The good return it has achieved is mainly due to the contango decay of the VIX futures - it is short the futures, so it reaps the reward of the decay.

This is further amplified by the low volatility of volatility we've seen these past 2 years. This VoV can be seen more clearly in this chart - the spikes in volatility (VIX) have been getting increasingly smaller (yellow wedge).

Risk and Return characteristics:

 

Comparing SVXY against an investment in SPY for the periods Oct-2011 (inception of SVXY) to Aug-2017

Maximum drawdown: SPY = 14%, SVXY = 68% (about 5 times larger)

You can also see that the drawdowns for SVXY are in the ranges of 20% whereas the SPY has fared with about 5%.

Price return: SPY = 113%, SVXY = 1300% (about 11.5 times larger)

Though it may seem worthwhile - 11.5x larger returns for 5x more risk - do take note the drivers of return are different.

How to trade SVXY:

 

1) Treat it like a stock and buy on dips - but be prepared for the steep drawdowns, and also to cut losses if a panic mutates into a bear.

In bear markets, VIX futures tend to go into backwardation and remain at elevated levels for longer than usual, depriving SVXY of its drivers of return. Even the 2015 scare caused SVXY to go into 65% drawdown and did not recover until 547 days later (23-Jun-2015 to 21-Dec-2016). Also that rout wiped out about 3 years worth of gains (ouch) so I don't suggest holding for long term.

For buy entry signals, you can consider using a simple Bollinger band strategy.

2) Option spreads - these are a good way to make short term directional calls as you can tailor it to limit your risk and target a certain price zone. The only limitation is that bid-ask spreads tend to be a bit wide, so you have to be a bit picky on the strikes and dates.

Shown below is the return distribution for a 5-day holding period (Weekly options). The modal weekly return since inception is in the 2-4% range, with this being especially pronounced for these past 2 years. Work out the probabilities and find a favourable spread. 

If you like to go across dates (diagonals etc) it is somewhat safe to rely on option payoff models here, as they don't model is as wrongly as they do for options on VIX. However do note that the standard problems apply - intrinsic values tend to drop when prices go up.