Era of Calm Ends as Volatility Returns to Markets

With the return of volatility in stocks, those investors and trades that profit when markets are calm are suffering heavy losses.
The above referenced WSJ article (published yesterday) tells a very interesting story about volatility as an asset class. VIX exchange-traded products (such as Credit Suisse’s now infamous and soon-to-become-defunct) VelocityShares Daily Inverse VIX Short-Term exchange-traded note (XIV)) were originally conceived of in the aftermath of the global financial crisis as a form of insurance against against increases in market volatility.
As we have previously discussed (see “On the relationship between the S&P 500 and the CBOE Volatility Index (VIX)“), returns on the S&P 500 stock market index and VIX tend to be strongly negatively correlated with each other.  Thus, VIX exchange-traded products such as XIV offer investors the opportunity to hedge against increases in volatility.  Indeed, by reversing the letters in the VIX ticker symbol, the VelocityShares Daily Inverse VIX Short-Term exchange-traded note in particular effectively branded itself as a financial product which hedges volatility.  However, as market volatility subsided during recent months and years, many investors began to sell rather than buy products such as XIV in hopes of boosting portfolio returns.  With stocks trading at historically low volatility levels lately, this strategy seemed to be working pretty well for many investors; that is, until this past week when volatility made its comeback:
The next graph shows the time series for daily closing prices on XIV and on VIX, from 11/30/2010 (which is the first day for which daily data for XIV are available) through yesterday (2/6/2018):
 Within this date range, the correlation between XIV and VIX is -.5608.  Of course, the most interesting aspect of this graph corresponds to the enormous drop in XIV from its all-time closing high of 144.75 (on January 12, 2018) to 7.35 at the close yesterday.  On the same day that XIV reached its all-time closing high,  VIX closed at 10.16, but stood at 37.32 at the close on Monday, February 5.

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