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Petsis Posts #3: Leveraged ETFs in a Market that Corrects

| February 12, 2018

"In investing, what is comfortable is rarely profitable." - Robert Arnott

It can be uncomfortable to stay put when markets are volatile. Sometimes it takes awhile to get back to that high you were at before. But if we stick to investing 101: Buy low, sell high, diversify and rebalance (which combines buy low, sell high and diversify) we usually end up making good investing decisions.

The problem is that we can't confidently follow these Investing 101 guidelines unless we add one more thing in light of recent events: understand what you own. Putting more bad dollars into a product you don't understand rarely makes for a pleasant investing experience, as we'll see below.  

The products I am alluding to are above are VIX related and VIX inverse ETPs (exchange traded products.) Blackrock, the largest ETP provider in the world commented that “‘much of [last] week's market tumult arose from huge losses in exchange-traded products that work off volatility.’” Carl Ichan issued a similar warning last week on CNBC. The specific ticker blamed for some of the volatility has been $XIV, the Credit-Suisse VelocityShares Daily Inverse VIX ST ETN. Without getting too technical, this $XIV ETN (exchange traded note) is supposed to profit when the VIX, the most used market volatility index, is low and decline when the VIX is high. With the swings in the market and the spike in VIX volatility jumping 30% at points last week, the $XIV ETN declined sharply.

How can an ETN declining cause such mayhem? Check out the below, a Reddit user’s profit and loss statement for his “client” accounts…yikes. As you can imagine, as this article with a very clickable tagline gained huge popularity, it started to shine a national spotlight on these VIX related ETP positions.

This $XIV ETN could have been used as a hedging position for a basket of stocks that did well when the VIX was high. When the VIX was low, XIV would then theoretically profit and smooth out the returns of this hypothetical portfolio. Compare my hypothetical scenario to how the $XIV appears to have been used as a core holding in the Reddit user's accounts. Which of us could buy low, sell high, diversify, rebalance and understand how what we owned worked in the context of their portfolios? 

Attached is the article below here if you’re interested:

Buy Low, Sell High. Diversify. Rebalance. Know what you own.