When I logged into my trading software today I have to admit I did a little double take.  Was I seeing that correctly?  S&P 500 futures are red?  I thought the whole world agreed stocks won’t ever go down again? 

So perhaps some of you are wondering, if the S&P 500 drops X% in a day, how much will the XIV drop?  What this question is essentially asking is:

 

What is the Beta of the XIV?

 

Beta is a measure of the volatility or systematic risk of a security with respect to the market

So the answer:  The XIV has a Beta of about 4.24 

 

(I calculate my beta on S&P 500 moves greater than 1% to clean up some of the lower end noise)

 

So if the S&P 500 drops 1%, on average the XIV will drop 4.24%.  If the S&P 500 drops 3%, on average the XIV will drop 12.72%.  So it actually has a very high Beta which is why we do always want to be careful when we trade the XIV.  I personally believe reducing our overall exposure to the market  (being in cash)  is the best first line of defense against unexpected crashes.  Essentially we target the low hanging fruit, and try to avoid all the more uncertain periods. 

But more interesting is the fact that XIV Beta is rising with each passing year.  Here we look at the Beta for the first half of values since inception in November 2010, compared to the second half.

 

 

We can see this rise in XIV Beta is even more pronounced when we divide the periods up into quarters:

 

 

XIV Beta is over 5 in the last couple years which means that it moves about 5 times as much as the S&P 500 does on average.  That may be a little worrisome to those who know the S&P 500 does occasionally suffer significant drops.

Now I’m not trying to be negative here or scare anyone, but it is my job to make sure that we aren’t taking on any excessive risks in our trading.  Essentially I get the rate of return I have over the years because sometimes I see things, and track variables that other people may not.

Remember, there is no reward without risk.  When you see the XIV shooting up, it’s not without it’s potential risks.  Take a look at the XIV Beta this year:

 

 

Now of course the most recent 3 data points isn’t a very robust data set, but I do think it is worth noting that the last 3 S&P 500 drops we’ve seen, and the last 3 VIX spikes that we’ve seen, saw MASSIVE relative crashes in the XIV.

An average XIV Beta of nearly 10 in 2017.  Again, not trying to scare anyone.  In my opinion the reward of investing in volatility products is worth the risk and we’ll be doing it for many years to come.  But that doesn’t mean we have to just buy it blindly.  We can strategically pick our spots.

 

Again it’s about reducing risk and targeting the low hanging fruit.  All time records for low volatility is an extreme outlier, and not at all what I would call low hanging fruit.

 

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