SVOL - SVOL: Time To Dip Our Toes In
Summary
- SVOL ETF generates high distribution yields by shorting VIX Futures.
- It provides -0.2 to -0.3x VIX exposure while hedging tail events with UVXY calls.
- With VIX at 33, investors can tactically accumulate shares.
I first wrote about the Simplify Volatility Premium ETF ( SVOL ) a few months ago, noting it generates a high distribution yield that is generally uncorrelated to the markets.
Although markets can enter a true panic phase and VIX can spike to 40 or higher, with the spot VIX index at 33 currently, now may be a good time for investors to start tactically accumulating shares of the SVOL ETF.
Brief Fund Overview
The Simplify Volatility Premium ETF seeks to provide investment returns that correspond to 0.2x to 0.3x the inverse of the S&P 500 VIX short-term futures index, with a hedge on for extreme events.
Investors who want more details on the mechanics of the fund should take a look at my prior article .
Short-Volatility Starting To Look Interesting
Shortly after writing my prior article, I noted that with the spot VIX index at trading at 21, it probably wasn't the best tactical entry point (Figure 1).
Figure 1 - Tactically not the best time to short vol at 21 VIX (Seeking Alpha)
My comment proved prescient, as the S&P 500 topped out shortly afterwards and has given back all of the summer-time rally in September (Figure 2).
Figure 2 - S&P 500 Has Since Given Back Summer Rally (stockcharts.com)
With the S&P 500 now trading at 3,600 and the spot VIX index trading at 33, is now a good time to consider the SVOL ETF?
VIX Nearing Rarified Territory
If we look at historical closing VIX values, we find that since 1990, the spot VIX index has averaged 19.6, with a standard deviation ("SD") of 8.0. This means that at the current spot VIX levels of ~33, we are almost at 2 SD from the mean. Note, some market commentators have also been calling for a VIX level above 40 to signal capitulation.
Looking at the past 20 years, the spot VIX index has traded above the 2SD level during extreme panics like the 2008 Great Financial Crisis ("GFC"), the 2010 and 2011 European Debt Crises, the 2015 Chinese Yuan Devaluation, and the recent COVID pandemic. So we are nearing rarified territory (Figure 3).
Figure 3 - VIX Above 2SD Signals Market Panics (Author created with price chart and data from stockcharts.com)
Note, the VIX index does not follow a normal distribution, it has a notable right tail; so it is not mathematically correct to model the VIX index using a normal distribution (Figure 4). However, for market analyses, it does signal potential peak fear when we have high spot VIX index values.
Figure 4 - VIX Index Is Not Normally Distributed (Author created with data from stockcharts.com)
While nobody has a crystal ball and we could see a true panic VIX spike like what happened in March 2020, with VIX at 33, history suggests shorting VIX is starting to look attractive.
Inverted VIX Curve Points To Oversold Conditions
Another indicator I like to monitor is the shape of the VIX Futures curve. An inverted VIX Futures curve is often a signal of an oversold market, as investors panic buy near-term protection. Currently, the VIX Futures curve is inverted out to May 2023 (Figure 5).
Figure 5 - VIX Futures Curve Inverted (vixcentral.com)
SVOL Could Be Better Than XYLD At Generating Yield
When it comes to generating high distribution yield while providing market-like exposure, I believe the SVOL ETF has a better mouse trap than call writing strategies like the Global X S&P 500 Covered Call ETF ( XYLD ).
So far, during the bear market in 2022, this has proven to be true, with the SVOL ETF delivering total returns of -13.0% vs. XYLD at -17.4%. The SVOL ETF also has generated a higher YTD distribution of 10.5% vs. 8.4% for XYLD (Figure 6).
Figure 6 - SVOL vs. XYLD ETF YTD 2022 (Author created using Portfolio Visualizer)
My hypothesis is that this may prove to be true during bull markets as well, because call writing strategies like the XYLD trade away part of their upside for option premium, whereas the upside on SVOL is uncapped. However, this hypothesis remains to be proven.
Risks To Owning SVOL
The big risk to owning the SVOL ETF is a true panic event where volatility spikes and does not mean revert in a short period of time. As I have written before, short volatility ETFs like the VelocityShares Daily Inverse VIX Short-Term ETN ("XIV") were blown up in 2018 when VIX doubled overnight. SVOL appears to be protected somewhat from this tail event, as it owns call options on the ProShares Ultra VIX Short-Term Futures ETF ( UVXY ), as shown in Figure 7.
Figure 7 - SVOL Holdings (simplify.us)
Another potential risk to SVOL is if the VIX Futures curve remains inverted for a long period of time. SVOL generates returns by shorting near month VIX Futures (SVOL shorts 1st and 2nd month) and relies on the normal 'rolling' of the futures to lower values (futures curve in backwardation). When the futures curve is inverted, the expiring future is actually higher in value and is replaced with a short on a lower-valued 2nd-month future. If this curve inversion dynamic persists, the SVOL will lose money.
Conclusion
Although markets can enter a true panic phase and VIX can spike to 40 or higher, with the spot VIX index at 33 currently, now may be a good time to start tactically accumulating the SVOL ETF. The SVOL ETF generates high distribution yields by shorting VIX Futures. It is protected from Armageddon events with small call positions on the UVXY ETF.
For further details see:
SVOL: Time To Dip Our Toes In