Shares of Cboe Global Markets, Inc. (NYSEMKT:CBOE) are falling today, down by about 12% as of 11:30 a.m. EST. Investors are worried about how the failure of some products designed to short the VIX index will affect Cboe Global Market's VIX-related volume, revenue, and ultimately, its earnings.
Cboe Global Markets provides the exchanges on which buyers and sellers of options, futures, and other derivatives meet. In recent years, its growth has been fueled by complex products, including VIX index futures and options, which allow traders to bet on whether markets will become more or less volatile. The VIX is often referred to as the "fear gauge," since it measures implied volatility of S&P 500 stock prices based on how much investors are willing to pay for options to hedge their risks.
A research report by KBW published on Tuesday estimated that as much as 20% to 25% of Cboe Global Market's revenue was generated from products related to the VIX, according to Business Insider. Much of that volume and related revenue could dry up, however, as exchange-traded notes (ETNs) linked to the VIX index are shuttering their doors.
For a long time, shorting the VIX was a profitable trade. In the five years leading up to market close yesterday, the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV) generated a compounded annual return of 35.7%, easily outpacing the stock market average. Many investors hopped on for the ride, viewing this ETN and others like it as a way to make a highly leveraged bet that stock prices would go up and up, and with little volatility along the way.
But as many people found out yesterday, there are no risk-free ways to make exceptionally high returns. The VelocityShares Daily Inverse VIX Short-Term ETN saw its net asset value plunge from more than $108 to $4.22 per share in a single day due to a spike in volatility. Its sponsor, Credit Suisse, says it will fold up the ETN, liquidate it, and make a cash payment to its owners, locking in losses for those who hold it. (The chart above doesn't fully reflect the decline in VelocityShares ETN's value, since trading is currently halted.)
Between the VelocityShares Daily Inverse VIX Short-Term ETN and ProShares Short VIX Short-Term Futures ETF (NYSEMKT:SVXY), as much as $3 billion of investors' wealth could have simply evaporated in a single day of trading thanks to a massive, one-day surge in the VIX.
Cboe Global Markets, which derives a portion of its revenue from volatility-related trading, will naturally see revenue from ETF and ETNs that short the VIX dry up, as investors turn away from the strategy in light of large losses. Importantly, many of the people who held ETNs and ETFs that short the VIX were retail investors who wouldn't otherwise speculate on the VIX if not for the fact that ETFs and ETNs made the strategy available to them. These retail speculators are unlikely to move from ETFs and ETNs to trade VIX futures or options directly.
To be clear, this isn't a failure of Cboe. Markets simply went the wrong way for the people who held ETFs and ETNs that were short the VIX. That said, a decline in VIX-related volumes could be a short-term headwind for the exchange operator, as it has benefited indirectly from large bets against market volatility.