VelocityShares’ Daily Inverse VIX Short-Term ETN (NASDAQ:XIV) and its sister fund, the Daily Inverse VIX Medium-Term ETN (NASDAQ:ZIV), are designed to go up when the volatility of the S&P 500 goes down. XIV has a shorter time horizon (1 to 2 months) whereas ZIV has a 5 month timeframe.

To have a good understanding of how XIV works you need to know how it trades, how its value is established, what it tracks, and how VelocityShares (and the issuer- Credit Suisse) make money running it.

How does XIV trade?

  • For the most part XIV trades like a stock. It can be bought, sold, or sold short anytime the market is open, including pre-market and after-market time periods. With an average daily volume of 11 million shares its liquidity is excellent and the bid/ask spreads are a penny.
  • Unfortunately XIV does not have options available on it. However, its Exchange Traded Fund (ETF) equivalent, ProShares‘ Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) does, with five weeks’ worth of Weeklys with strikes in dollar increments.
  • Like a stock, XIV’s shares can be split or reverse split-but unlike the iPath S&P 500 VIX Short-Term Futures ETN (VXX) (with 3 splits since inception) XIV has only split once, a 10:1 split that took its price from $160 down to $16. Unlike VXX, XIV is not on a hell-ride to zero.
  • XIV can be traded in most IRAs / Roth IRAs, although your broker will likely require you to electronically sign a waiver that documents the various risks with this security. Shorting of any security is not allowed in an IRA.

How is XIV’s value established?

  • Unlike stocks, owning XIV does not give you a share of a corporation. There are no sales, no quarterly reports, no profit/loss, no PE ratio, and no prospect of ever getting dividends. Forget about doing fundamental style analysis on XIV. While you’re at it forget about technical style analysis too, the price of XIV is not driven by its supply and demand-it is a small tail on the medium sized VIX futures dog, which itself is dominated by SPX options (notional value > $100 billion).
  • The value of XIV is set by the market, but it’s tied to the inverse of an index (the S&P VIX Short-Term Futurestm) that manages a hypothetical portfolio of the two nearest to expiration VIX futures contracts. Every day the index specifies a new mix of VIX futures in that portfolio. For more information on how the index itself works see this post or the XIV prospectus.
  • The index is maintained by the S&P Dow Jones Indices and the theoretical value of XIV if it were perfectly tracking the inverse of the index is published every 15 seconds as the “intraday indicative” (IV) value. Yahoo Finance publishes this quote using the ^XIV-IV ticker.
  • Wholesalers called “Authorized Participants” (APs) will at times intervene in the market if the trading value of XIV diverges too much from its IV value. If XIV is trading enough below the index they start buying large blocks of XIV-which tends to drive the price up, and if it’s trading above they will short XIV. The APs have an agreement with Credit Suisse that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep XIV’s tracking in good shape.