Inverse VIX ETN Shuts Down

ETrade Bans Margin Trading on Volatility ETF as Swings Increase

iPath S&P 500 VIX Short Term Futures ETN (VXX) Stake Boosted by Gilder Gagnon Howe & Co. LLC

Intercontinental Exchange Inc. (NYSE: ICE), which owns the New York Stock Exchange (NYSE) and many other exchanges, was last seen down just 1.3% at $70.50 right before noon Eastern Time on Tuesday.

The gauge of USA stocks volatility known as VIX, which tracks the volatility implied by options on the S&P 500, recorded its biggest one-day surge in more than two years as investors rushed to buy derivative products to protect against a further slide in stock prices.

These funds try to track the inverse of the CBOE Volatility index, and use derivatives to replicate the inverse action of the VIX on a daily basis.

The product was devised in order to benefit from the calming impact on the stock markets of initiatives such as quantitative easing.

Many of these products were sold on a leveraged basis, meaning investors buying notes tied to measures of volatility could take large bets for little upfront cash.

Credit Suisse Group AG, which issued the VelocityShares notes, traded down 6 percent after-hours.

Last year, traders argued that the VIX remained depressed because realized volatility in USA equities has diminished and economic fundamentals remain supportive.

The was an inverse bet on volatility, in this case, a basket of volatility futures (the two front-month VIX futures contracts).

Even one of the foremost pioneers of modern volatility got in on the criticism - in an interview with Business Insider, the Hebrew University of Jerusalem professor emeritus Dan Galai described the capital being used to short the VIX as "stupid hot money", and he likened the trade to "a substitute for going to Vegas and betting on the roulette".

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And amid the market turmoil overnight, the S&P500 VIX Index jumped by more than 100% to close at a reading of 37.32. "It's important to note that products linked to volatility do not cause volatility", he said.

Investors said the proliferation of short-term traders, some using computers to trigger trading decisions, had also exacerbated the price swings of the past few days.

For a long time, shorting the VIX was a profitable trade.

The repercussions have been severe for some funds. The prospectus outlines the procedure for shutting down the short-VIX product if it falls more than 80% intraday.

Cerebellum GP LLC purchased a new stake in iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA:VXX) in the 4th quarter, according to its most recent filing with the Securities & Exchange Commission.

There are some similarities to the volatility trade and the "short volatility" trades actually creating moves in the underlying equity markets being similar to credit default swaps (CDS) ahead of and during the financial crisis of 2008 to 2009.

To be sure, the market wasn't down just because of these complex volatility instruments.

VIX futures contracts fell back on Tuesday to trade at a wide discount to the spot price, showing that traders expected volatility to fall sharply. The market was extremely volatile on Monday, of course.

Cboe Chief Operating Officer Chris Concannon said it was likely that regulators would take a closer look at these products. To professional investment managers, volatility is measured in multiple ways.

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