XIV: What It is and What You Need to Know

XIV: VelocityShares Daily Inverse VIX Short Term ETN is a wildly popular VIX ETF that can play a significant role in an investor's or trader's portfolio.

Volatility has been described as the new asset class in the futures market, allowing traders to benefit from and prepare for both rising and falling market conditions.

Whereas exchange-traded notes (ETNs) like the iPath S&P 500 VIX Short Term ETN (NYSEARCA:VXX) are designed to track the performance of the VIX Volatility Index through futures contracts, other ETNs like the XIV trade inverse volatility, allowing investors to seek profits when volatility declines.

When it comes to inverse volatility, the VelocityShares Daily Inverse VIX Short Term ETN (NYSEARCA:XIV) is widely considered to be a top choice because of its very high liquidity, low bid-ask spreads and potentially profitable returns. As you'll soon find out, the XIV can be beneficial in spurts, but if held for too long can expose investors to volatility drag.

XIV: An Introduction

Investors are interested in inverse volatility because they know that, over the long term, the advantage is on their side. Since volatility has a tendency of returning to the mean, buying inverse volatility at the right time - say, when the VIX is well above 20 - can greatly enhance profitability. That's where the XIV Short Term ETN can come into play.

The XIV, which was established by Credit Suisse and began trading in 2010, tracks the daily percentage inverse movement of the VXX, holding approximately 75% of its portfolio in front-month VIX futures and the remainder in VIX futures in the following month.

Like other volatility ETNs, the XIV enjoys very high liquidity. With an average daily volume of around 19 million shares, it offers lower spreads and many opportunities for entry and exit. Since the volatility market is normally in contango - a state where the futures price of a security is above the current price, indicating that people are willing to pay more for the security at some point in the future - XIV shouldn't be considered a long-term investment strategy.

XIV tends to move in correlation with the S&P 500 (NYSEARCA:SPY) only at a much faster rate of change.  Since conventional wisdom says that stocks move higher 75-80% of the time, XIV should offer profitable movements at about the same percentage.

But, as seen in the chart below, XIV can be extremely volatile and so is not appropriate for a buy and hold strategy or as a long term investment.

xiv, velocityshares daily inverse vix etn, Nysearca:xiv

chart courtesy of StockCharts.com

Trading XIV

While XIV may not be considered a long-term investment, when used properly it offers significant profit potential.  However, investors must be acutely aware that VIX futures - the contracts the XIV is inversely tracking - occasionally experience large swings and these can lead to both large and fast profits or losses.

This isn't unexpected, either, given the volatile nature of today's global financial system and the myriad of factors that could impact investor sentiment. Although most experienced investors realize that volatility will always make its return, it can also disappear relatively quickly.

Unlike leveraged products, the XIV tracks the daily percentage moves of the VXX on a negative one-to-one basis, making this ETN much easier to follow.

While it may be tempting to view the XIV as a true short of its tracking index - namely the VXX - the reality isn't so simple. The XIV traces the negative inverse of the index each day before rebalancing investments at the end of the trading session. One of the best arguments for rebalancing is that a true short ETN would be limited to gains of no more than 100%, at least in theory. The XIV, on the other hand, has gained more than 100% since its inception and at one point was up more than 200%.

The XIV offers traders and investors the opportunity to seek profits in both up and down stock markets and when volatility is rising or falling.

During up times in the stock market, volatility is typically falling and so XIV can generate profits under those conditions.  During down times in the stock market, volatility is typically rising and so XIV would be in decline while VXX would typically be rising. The easiest way to go about trading the XIV is to view it, at least conceptually, as the inverse of the much more popular iPath S&P 500 VIX Short Term Futures ETN (VXX) or as an ETN that follows the movements of the S&P 500.

Like other ETNs, the XIV is best traded using a combination of fundamental and technical indicators, including the Relative Strength Index (RSI), 2 Period RSI, Point and Figure Charting and MACD. These tools provide a complete picture of volatility and its inverse and can form the basis for a successful trading system that can be applied to both up and down markets.

While the VIX Index is a major asset class and VIX ETFs trade large volumes per day, there is widespread misunderstanding about these ETNs and how they should be used.  TradingGods.net publishes VIX Trader which is an educational trading program and system that focuses on XIV and VXX and how to trade these dynamic ETNs.  Check out VIX Trader to learn more about XIV: VelocityShares Daily Inverse VIX Short Term ETN.

 

Sources:

Vance Ward (April 23, 2015). "How Does XIV Work?" Six Figure Investing.

Vance Ward (July 31, 2015). "Inverse volatility-the winner for Short Term is XIV." Six Figure Investing.

John Edwards (October 15, 2015). "Top 3 Inverse Volatility ETFs (XIV, SVXY).