Returns of volatility products during the August 2024 stock market selloff and the impact of shortable share availability, borrow rates, and retail trading blackouts

On July 31, 2024, the Bank of Japan raised its policy rate from 0.10 to 0.25% which exacerbated an already strengthening Japanese yen against the U.S. dollar. Since July 10, the yen had already appreciated 7.34% against the dollar putting negative pressure on the “yen carry trade” where investors borrow Japanese yen at the lower yen interest rate and invest the U.S. dollar proceeds into higher-yielding assets. The next day, U.S. data showed weakness in manufacturing and an increase in initial unemployment claims. On August 2, the unemployment rate increased to 4.3% triggering the “Sahm Rule” which has historically indicated that the U.S. is in a recession. Warren Buffet also revealed that he had sold a significant portion of his stock in Apple. Howard Marks from Oaktree Capital Group in his August 22 memo Mr. Market Miscalculates describes this as, “a triple whammy. The resulting flip-flop from optimism to pessimism set off a significant stock market rout.”
 
The S&P 500 declined to a low of -7.30% on August 5 from its July 31 close. Japan’s Nikkei 225 was rattled worse, falling to a low of -15.87%. The abrupt increase in market volatility caused the CBOE S&P 500 Volatility Index VIX to spike from 16.36 on July 31 to a high of 65.73 during the pre-market hours on August 5, its highest level since the stock market crash of March 2020.

The increase in trading volume caused outages at all the major retail brokerages including Fidelity, Charles Schwab, Vanguard, E-Trade, and Interactive Brokers beginning shortly after 09:00 and lasting until 11:00.
 
The immense spike in the VIX was matched only by an equally dramatic decline, having closed at just 38.57 by the end of trading on August 5 and 14.80 on August 16. This represents a gain of +301.77% during the run-up from July 31 to August 5 and a decline of -77.48% from August 5 to August 16.
 
The large moves in the VIX provide attractive yield opportunities for investors willing to stomach the immense price moves and risks. The VIX cannot be traded directly beyond its listed index options which has led to the creation of a plethora of exchange-traded products that attempt to represent the VIX index via futures contracts. Table 1 outlines the largest of these funds by assets under management (AUM).

Table 2 shows the performance of long volatility strategy products including the front month VIX future contract VXQ24 (August 2024 expiration) and next month VIX future contract VXU24 (September 2024 expiration) from the July 31 close to the August 5 high price, and from the August 5 high price to the August 16 close.

For long volatility strategy products during the VIX run-up, UVIX performed best with a gain of 233.95% due to its 2x leveraged strategy, followed by UVXY at 161.18% with 1.5x leverage, followed by VX futures, which averaged a gain of 124%.
 
During the VIX rollover from August 5 to 16, UVIX performed worse with a -78.67% loss from the August 5 high, followed by UVXY at -69.93%, and VX futures with an average loss of -57%.
 
Shorting long volatility strategy products, outside of selling futures contracts, are limited by the availability of shortable shares. Returns are also reduced by exorbitant borrow rates. Table 3 shows the arithmetic average of the borrow rates and shortable shares available for long volatility strategy products at Interactive Brokers on July 31 and August 5.

Shares of VXX, the largest long volatility strategy product by AUM, were largely available for retail traders at a modest borrow rate of 3% but shares of UVXY, the second largest, were mostly unavailable, and shares that were available had a borrow rate of 40 to 50%.
 
Short volatility strategy products had a slightly more muted response to the August 5 VIX spike due to being unleveraged beyond -1x. Table 4 shows the performance of short volatility funds from the July 31 close to the August 5 low price, and from the August 5 low price to the August 16 close.

SVIX performed worst during the VIX spike with a -56.35% loss, followed by SVXY at -34.81%, and ZIVB at -23.97%. During the VIX rollover from August 5 to 16, SVIX performed best with a 68.11% gain, followed by SVXY at 38.52%, and ZIVB at 26.29%.

Retail brokerage outages

One severely limiting factor affecting retail traders’ ability to participate in the volatility moves on August 5 was that beginning around 09:20 ET major outages occurred at all the top retail brokerages including Fidelity, Charles Schwab, Interactive Brokers, and E*Trade. These outages lasted through 11:00 ET in some cases. A significant portion of the total moves in volatility occurred during the two-hour window between 09:00 and 11:00 when trading was unavailable. Table 5 shows the price action and performance of volatility products during retail trading blackout from 09:00 to 11:00 on August 5.

Table 6 shows the proportion of performance of volatility products during the retail trading blackout from 09:00 to 11:00 on August 5 as a percent of the total gain (loss) from the August 5 high (low) to the August 16 close.

41% of the move in VX futures occurred during the blackout, followed by 29% of the move in ZIVB, 23% of the move of SVXY, and 22% of the move in UVIX. The trading blackout reduced the possible returns in these products following the spike in VIX by an average of 8.24%.

Downdetector outages