The iPath S&P 500 VIX Short Term Futures ETN (VXX US) hit its historical closing low of $18.97 on Friday, January 27th and after a slight rebound is still down over 25% in 2017. The VXX ETF, which tracks the market’s expectation of 30 day volatility using the implied option volatilities of the S&P 500 index and is commonly called the Fear Index. Higher VIX and VXX levels occur when investors expect large moves in either market direction and are willing to pay larger put and call premiums in order to take on risk positions or hedge their portfolios.
Investors are torn between thinking the index will go up or down in the near term with the VXX’s long market cap at $1.15 billion and its short interest just slightly lower at $950 million. The VXX ETF has been trending downward every year since its inception in 2009, averaging a yearly decline of 49.28%. VXX’s average short interest has decreased slightly over the last several years falling from $1.2 billion in 2015, to $1.0 billion in 2016 to $0.9 billion so far in 2017.
Investors have continued shorting VXX shares over time in order to keep their USD exposure relatively flat even as VXX’s stock price declines. From 1/1/15 to today the total amount of VXX shares shorted is up 265%, but the actual USD exposure (USD at risk) is down 12%. This exemplifies the fallacy of looking at shares shorted or shares shorted as a percentage of float as a proxy for actual short activity. Hedges, risk positions and profits are measured in currency not shares, being short 5% of Dryship’s float is very different from being short 5% of Berkshire Hathaway’s float.
Nearly three months after President Trump’s election the VXX is down 40.55%, implying that investors are predicting less volatile performance of the S&P 500 even though volatility in the change of executive government policy is high. VXX short interest since November 8th has averaged $909 million and with such a high percentage of its market cap already on loan the cost to borrow shares is averaging just over 3% fee. Short sellers have paid $6.2 million to finance their stock borrows since the election but their returns were well worth the higher than average stock borrow costs. Short sellers earned $481.5 million in mark to market P\L in just under 3 months, for a net of financing return of 52.95%.
Investors who went against the perception that Trump’s presidency would immediately add volatility to the S&P 500 and shorted the VXX as a hedge or an outright risk position ignored the political distractions and made the right choice. But if the VXX reverses course, short sellers will probably be quick to cover in order to reallocate their hedges or realize their profits. We would then see a quick drop in short interest and a tailwind for VXX’s stock price once it begins to move upwards in earnest. Until then, shorts will continue to short shares in order to keep their net exposure between $900 million and $1.1 billion and keep generating daily mark to market profits.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC Ihor.Dusaniwsky@S3Partners.net
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