ZIV ETF: how to short volatility

A lot of people want to know how to boost investment returns and how to short volatility. The most common suggestions involve high-yield blue-chip dividend stocks, junk debt, REITs, MLPs, covered calls, and preferred stocks. Recently, short volatility products such as the ZIV ETF have been added to the list. You know what all of those suggestions have in common?

They can all tank 50+ percent.

ZIV ETF: How to Short Volatility

If you don’t want to constantly trade but still want to know how to short volatility, my slightly unorthodox solution involves marrying two inversely correlated ETFs and then using a variation of core trading to create a synthetic high yield investment with significantly less risk than any of the other options listed above. The trick to shorting volatility is to think of it as a yield enhancer versus something you’re trying to shoot the moon with.

Over the past 5 years an allocation of 95 percent to IEF and 5 percent to the ZIV ETF would have generated a ~2.9 percent return versus a return of ~2.1 percent for IEF on a standalone basis. That doesn’t seem like much of an improvement, but an extra one percent return per years adds up over the long-term. Most notably, the addition of ZIV helps mitigate the pressure from a rising rate environment.


The reason this works is because you’re taking ZIV, which is a volatile asset with surprisingly high short-term expected value due to contango, and combining it with IEF, which is a comparatively stable asset that usually benefits from a flight to safety, and then systematically selling insurance when insurance is dear and buying it back when insurance is cheap.

ZIV ETF Risk Management

The other reason this synthetic high yield investment strategy works is because of the ETF wrapper of ZIV. By offloading the risk management part of selling volatility insurance to VelocityShares you’re not left on the hook if the VIX blows up as spectacularly as it did back in February when I wrote XIV – A Friendly Reminder.

XIV is just the latest reminder of one of the truths of trading and investing: there are a lot of relatively easy ways to quickly make a little money but it is extremely hard to quickly make obscene amounts of money. When traders or investors try the latter, they often fail like XIV: in a most spectacular fashion.

Combining IEF and ZIV ETFs into a synthetic high yield investment is one of the relatively easy ways to quickly make a little money.

And yes, I just quoted myself.

ZIV ETF: the fine print

Ziv is an ETP that shorts medium-term VIX futures. ZIV’s value is tied to the daily resetting inverse of the S&P VIX Medium-Term Futures that specifies a hypothetical portfolio of VIX futures with 4 to 7 months until expiration. About 75 percent of the time the medium-term VIX futures are in contango, which means longer-dated futures are more expensive that the ones closer to expiration. Persistent contango is what creates an attractive short trade because as long as contango persists the VIX futures shorted by ZIV will tend to go down in value over time.

The reason this attractive trade exists is because every now and then the VIX, and the medium-term VIX futures the ZIV ETF is short, will spike hard and cause massive drops in the value of ZIV. The reason ZIV is attractive is because medium-term futures are less volatile than short-term futures. However, drawdowns of 30+ percent seem to happen about once a year.

Additionally, if the ZIV ETF drops 80 percent or more in a single day it will likely terminate. Theoretically an event like 1987’s crash would need to occur before this would be a possibility. However, if XIV or SVXY taught us anything, it’s that things that are theoretical can often become reality.

ZIV Core Trading Rules

The rules of trading IEF and ZIV ETFs are simple. This assumes the portfolio is allocated 95 percent to IEF and 5 percent to ZIV.

  1. Whenever ZIV represents 7.5 percent of the portfolio, sell it back down to 5 percent and invest the proceeds of the sale in IEF.
  2. Whenever ZIV represents 2.5 percent of your portfolio, buy enough using proceeds from IEF to get the allocation back to 5 percent.
  3. If VIX is less than 10, sell all of your ZIV position and wait until volatility spikes back up.

The above rules are simple enough that anyone can use them to create their own relatively safe high yield investment. The only requirement is that a person pays attention and has the fortitude to buy more when others are panicking and take some profits when things are calm. If you want to be a lazy investor, instead of core trading the two ETFs just rebalance them once a year. The returns are pretty similar for both approaches.

The third rule exists to try to limit the damage of the VIX spiking since it’s much easier for the VIX to go from 8 to 24 than for it to go from 15 to 45. As a reminder: even though ZIV is a tame version of XIV, if VIX spikes more than 300 percent in one day then VelocityShares will self-liquidate the ETF and your position will be worth literally nothing.

Which leads me to…

Things Fall Apart

Even though the maximum drawdown for the above strategy is only ~8.8 percent, including the debacle that happened in February, 2018, there is always the risk that a particular future sequence of returns will make this strategy less successful. The chart below shows the fairly mild drawdowns of the strategy.


It’s impossible to say whether the sequence of returns risk will continue to be in ZIV’s favor. Even though you’re only on the hook for your 5 percent allocation, if we enter a period where the VIX spikes 300 percent on successive days after you’ve reloaded the allocation each time your portfolio can take multiple 5 percent hits. If it happens 4 times in a row without giving you time in between to make money by trading around the ZIV core position then your portfolio is down 20 percent. I would wager that if we have a sequence of returns where this actually happens then junk debt, preferred shares, and equities will all have taken an even worse beating.

Regardless, with anything you read on the internet: caveat emptor.

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