The riskiness of volatility products

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Firms Involved

  • Credit Suisse

Year of the event

January 2018

Description of the case

On Monday 5th of January 2018, the volatility of US equities, as measured by the VIX[1], skyrocketed by 116%. This caused some serious issues on instruments designed to allow investors to bet against an increase of volatility. In particular, the VIX, and exchange-traded note (ETN), lost 93% of its value. Credit Suisse consequentially shut down the ETN on the next day[2], in accordance with the prospectus which allowed the issuer to do so in case of daily variation of more than 20%. This instrument was available to retail investors, even though its structure, covenants and risk profile were highly complex to apprehend.

In addition, huge intraday tracking error made the instrument exceptionally inefficient at replicating such a bet, in particular throughout Monday 5th[3]. This was caused by the calculation method of the instrument, which relied on the prices of several futures on VIX with various maturities and not on the actual current VIX level[4].


Take-aways

  • Selecting the right instrument to place a bet is key. For that, prospectus need to be read. The working of the instrument used needs to be thoroughly understood.
  • In undertaking any kind of bet, beware of the tail risk (black swans).

References

  1. CBOE, VIX description page
  2. Credit Suisse, Press release, Credit Suisse AG Announces Event Acceleration of its XIV ETNs
  3. Bloomberg, Matt Levine, Inverse Volatility Products Almost Worked
  4. Credit Suisse, XIV Prospectus