SVOL - SVOL: Holding On Strong Despite Rising Volatility

2023-08-16 12:23:03 ET

Summary

• Simplify Volatility Premium ETF is a high-yielding income generating fund that sells VIX premiums to generate income.
• SVOL has been holding up well in the last month despite VIX being up 20%, with a 0.34% increase in the last month.
• SVOL has outperformed the overall market since its inception, with a total return of 24% compared to SPY's 11%.
• So far, it's been performing as expected, generating a high yield of 17% for investors on a consistent basis.

Simplify Volatility Premium ETF (SVOL) is a high yielding income generating fund that focuses on selling VIX (VIX) premiums to generate income. The fund has a dividend yield of 16%. I've written an article on SVOL a few months ago arguing that this fund can be good addition to an income-focused portfolio.

I am writing this update because we've seen VIX bottom out in late July and volatility has been rising since then, which made many people wonder if this is still a good fund to hold. In summary, I believe this is still a good fund to hold for income seeking investors, and it's been actually holding up surprisingly well in recent weeks with volatility rising rapidly.

In the last 1 month, VIX is up 20% but SVOL has been holding up surprisingly well. During the month SVOL's price was down close to -1% but it was mostly because of the monthly dividend it paid which was 30 cents per share (which is a monthly yield of 1.3%). After reinvesting the dividend, SVOL is actually up 0.34% month-over-month even with VIX being up 20% during this period. I find it impressive that a fund that generates income by shorting VIX futures is able to remain positive in a month when VIX was up sharply. Of course, I am not saying that if VIX were to rise another 20% from here in the next month that SVOL would still be positive, but so far it's been holding up pretty well.

This is partially because SVOL sells VIX futures which come with a time value just like option contracts. Since VIX futures have time values, they already assume that VIX will rise to a point. Even though SVOL is shorting VIX, it doesn't need VIX to fall in order to generate money. An environment where VIX is flat or even slightly up can still be profitable to SVOL. Last month when VIX bottomed, it seems many people actually loaded up on VIX calls and VIX futures because they most likely realized that at a low level of 12 VIX has very little downside but lots of upside potential, so time values in VIX options and VIX futures suddenly climbed. This was beneficial for SVOL even though many people probably thought the fund's income generation power would drop significantly when VIX is near the bottom.

Meanwhile, SVOL continues to outperform the overall markets ( SPY ) since its inception. The fund was created 2 years ago and its total returns since then is 24% while SPY was up 11% during this period (both including reinvestment of dividends). This is particularly impressive considering how volatile last year was and how VIX was as high as 37 at one point last year. With the fund delivering about 16% of a dividend yield, it could continue outperforming SPY as long as the index rises less than 10% annually. Historically SPY is known to rise about 8% per year so SVOL should be able to keep up with this for the time being unless SPY really starts having a monster rally all of a sudden.

VIX is one of those things that have a very strong tendency to regress to the mean. VIX rarely stays above 25 for extended amounts of time and it rarely stays below 13 for long. Even though the index can technically range from 0 to 100+, it spends about 95% of its existence in a range between 15 and 20, rarely rising above or falling below this range. This makes it very profitable to sell VIX options or VIX futures as long as one is properly hedged. Hedging is particularly important because VIX can quickly rise to very high levels without much of a warning. SVOL utilizes 2 types of hedging. First, it only uses 25% of its buying power so it has a leverage ratio of 0.25 and second, it buys out of money VIX call options in case VIX blows up suddenly like it did in 2018 and 2020.

Black swan events in VIX are very rare though. For example, in 2020 we saw VIX rise to the 80s but it took so much to get it there. We had a global shutdown of the entire economy, global panic and a stock market crash where SPY took a -35% dive in a few short weeks, not to mention multiple circuit breakers and limit down days. In 2020 VIX rose so fast but also it dropped almost as fast as it rose because VIX has a tendency to regress to the mean.

Last year we had a bear market where at one point SPY was down as much as 28% at one point but VIX only rose to the 30s during this time because the drop was more orderly in fashion as compared to what we saw in 2020. As a matter of fact, crashes like 2020 are extremely rare and most bear markets will look like what we saw last year in my view.

How did SVOL perform during this time? SVOL was actually down last year when VIX was at elevated levels and the stock market was in a bear market but it wasn't down as much as the overall market was. By mid-October, SPY had dropped from $480 to $350 which represents a drop of 28% and VIX was hanging out in the 30s but SVOL was only down from $28.5 to $24.5 representing a drop of -14% in total returns. Mind you, this includes reinvestment of dividends and the stock yielded about 17% last year so all this buffer came from dividends but still, it's a good indication of how this will perform during a typical bear market.

We don't exactly know how SVOL would have performed in an event like March 2020 but those events are super rare and the fund seems to be buying protective calls to protect itself from events like that. The fund would have probably lost a lot of value at first but would have likely recovered just as quickly in an event like that because it would keep rolling its short futures to later months (at a very rich premium I might add) and be able to take advantage of the sudden rise and drop in VIX but it would have been a total roller coaster ride and not for the faint of heart.

In general, SVOL is still performing nicely and as expected. In fact, it is acting better than my expectations in some ways especially in the last month when VIX has been rising sharply and SVOL has been holding up well. One can only hope that this performance continues moving forward and this fund continues to deliver good returns and predictable high yield income for investors.

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