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SEC Charges S&P Dow Jones for Failures Relating to Volatility-Related Index (sec.gov)
206 points by epa 27 days ago | hide | past | favorite | 70 comments

This bug had serious real-world consequences for real people: https://www.reddit.com/r/tradeXIV/comments/7vi6oa/xiv_after_...

I don't think these discussions are about the bug, but rather about being wiped out by what the vix did that day.

Which leads me to what I think is the real fuck up. Not only the index was also live during after hours, but the fixing used as the basis for the formula for the next day was set at a time after trading hours. I am not 100% sure but I don't think this was the case when the index was initially published.

What that meant was that to replicate the index, the market-makers of the XIV and other short-VIX ETNs had to hedge themselves in after-trading hours market, i.e. in a much less liquid market. And that's when the short-squeeze happened. Now would that short-squeeze have happened during trading hours when there was more liquidity? Possibly, you would need to ask a market participant. But at the minimum it made the problem a lot worse. And I am surprised no one got any heat for that.

Just want to point out that a "short squeeze" is not possible with these volatility ETNs. They are collateralized debt instruments for which there is an unlimited supply. The underlying for these products is /VX futures, which also have an unlimited supply. A short squeeze happens when short positions cannot be covered due to limited availability of the underlying.

XIV collapse was caused by an unprecedented spike in the VIX index.

A short squeeze also happens when you have forced buyers (desperate to close their short VIX futures position) with a limited supply of sellers. Which is exactly what happened that day. It’s not the VIX index itself that caused the XIV to be wiped out.

They would just have to pay the premium that short sellers were demanding. I see your point, but calling it a short squeeze seems odd to me.

"Volpocalypse" was indeed an unprecedented spike in IV, which the futures market was reacting to. Seems pretty different to me than the classic short squeeze scenarios of GME or Volkswagen.

Omg. You obviously have never traded a VIX future. There are not infinite counter parties.

Matt Levine's Bloomberg column discussed this contemporaneously (https://www.bloomberg.com/opinion/articles/2018-02-14/is-vix...). For Credit Suisse (issuer of XIV), hedging their exposure to XIV allegedly required buying volatility futures when the price increased. With limited liquidity, this moved the futures prices themselves. Credit Suisse has been sued (https://www.institutionalinvestor.com/article/b1rlv9r030854q...).

This collective price response wasn't a short squeeze, but instead it was closer to a gamma squeeze. It didn't rely on finite supply of any security, just limited liquidity and trade sizes large enough to move the market price.

no. it was caused by spike of vix futures.

And why do you think the VX futures spiked?

The XIV collapse happened on the largest single day percent change in VIX history. It’s a bit silly to say it was the only the futures but not the literal index they track.

Do you have any reason to support your insult that it’s ‘a bit silly’?

Because those of us who have extensive knowledge of volatility products (I was a specialist in VIX options at the CBOE, the first to make markets in VXX, and one of the largest traders in volatility ETF options over the past decade), believe that the spike in the VIX index was caused by arbitrageurs reacting to a spike in the VIX futures. And VIX futures were simply reacting to the order flow caused by the daily rebalancing of leveraged ETFs.

What research have you done to show evidence otherwise?

had vix futures stopped trading at 4:00 instead of 4:15, all would have been fine. The extra 15 minutes is what killed them due to path dependency. The XIV and SVXY reset at 4:15 instead of 4:00, so once the critical termination threshold was crossed, it was game over. Indeed, after 4:15 futures prices began to fall, but it did not matter and XIV was doomed even if vix went to 0.

lesson: path dependency is a @##!

This is a timing issue with the trading. ETFs stop trading at 4pm. And the index for the ETF is calculated at the future close time of 415pm. Eastern Time.

Sure, there's after market hours trading for ETFs but liquidity is probably a lot less after 4pm.

Nonetheless, the failure to calculate a live index after 4pm is probably close to irrelevant for the average investor here.

That subreddit reminds me I've been meaning to follow up on https://www.bogleheads.org/forum/viewtopic.php?t=288192 (outperforming the market by holding UPRO/TMF). Wish that person were still disclosing their returns over time.

Not sure if they outperform on a risk adjusted basis but both UPRO and TMF are 3x levered (55%/45% weight)

A more fair comparison would be like 33% UPRO and 66% TMF. This would get you a portfolio that is similar to SPY, but with some leveraged treasuries on top.

Regardless, bonds have done really well due to the drop in interest rates over the last 10 years and I doubt they can go any lower. Bonds will probably perform a lot worse in the future, unless the fed wants to try out negative rates (unlikely).

Also you don't need them to disclose their returns, you can construct your own version: https://www.portfoliovisualizer.com/backtest-portfolio

Edit: constructing the portfolio, it does seem to outperform SPY on a risk adjusted basis, with a Sharpe of 1.25 from 2010-2021. However, my caveat about bonds still stands.

Agreed, long Treasurys has a low reward, high risk setup. Particularly if you believe the inflation narrative.

The risk/reward in isolation isn’t useful, because the market has priced in and bid them up so to their favorable inverse correlation with equities the past 40 years. Assets are priced due to their usefulness in the risk/reward for a portfolio as a whole.

Who buys long treasuries other than the Fed?

Pretty much every nation that has a trade surplus with the USA, worse it's also possible that a trade surplus between two non USA countries can result in the purchase of treasuries if they transact in USD.

I say "worse", because this money can only enter the US economy by making the government run a deficit, if it does not do this then unavoidable unemployment is the consequence.

They’re projecting future returns and correlations based on past 50 years (the ones we have easily available financial data) on constantly lowering interest rates. If asset inflation already pumped up both long term treasuries and stock assets (which pumped up 3x levered UPRO and TMF), then a follow on interest rate increase will equivalently destroy a stock asset and long term treasury portfolio, triply so for those. They think they’ve found an edge in the market (lol like major financial players don’t know about long term treasury and stock asset inverse correlation the past 40 years), but in reality they’ve just ignored the potential for substantial interest rate increases, because it’s not in their data, and they’re pocketing the extra on top until it blows up (they don’t realize it will).

No. The connection you're making is not correct. Since the GFC we were in a very low vol environment (2008 to 2017) so people shorted vol, picking up pennies, for years... Via XIV. The size of the fund caused it to blow up on one vol spike day. It's built into the mechanics of the fund. And has nothing to do with the fact that the index calculator failed to provide a realtime price after hours.

its not a bug, it was a undisclosed "feature"

Interesting hn link from those days: A Tiny Hedge Fund Made 8,600% on a Vix Bet <https://news.ycombinator.com/item?id=16346175>

Some people lost it all, and S&P DJI gets away with a paltry $9M penalty.

Unfair, no doubt.

But people who have lost everything in one go? That can only be the result of either grave incompetence/inexperience, or behavioural problems of the kind that don't go so well with trading.

Whatever it was that made them put all their eggs in one basket, these people should not have been making - or even have been able to make - these trades in the first place.

This is a dangerous way to legitimate peoples loss.

Not only is it encourages to put all you eggs in one basket, it is also society facilitated to do it with a 5, 10, 15 x gearing.

Yes, I talk about real estate.

It’s not really that much leverage if you go by lifetime earnings / savings potential. which is why you won’t get the same loan without a proportional w2 or otherwise taxable income.

Yes, it was rather late when I wrote that comment, but that's essentially what I was trying to say.

Of course these people did this to themselves, but perhaps they shouldn't have been able to pile on this much risk, or even have had this type of trade available to them in the first place due to suffering from diagnosed mental health problems, or for having recently displayed behaviour that is indicative of addiction.

The crypto exchanges are also ridiculous. 125x Leverage on Bitcoin, available to anyone who wants it with only a cursory ID check. Most of these apps are also plastered with ads for their own internal gambling products (e.g. "Battle to win, long vs short").

There is a new XIV-like ETF just launched called SVOL. It reduces the exposure level and hedges risk with options (XIV ended up collapsing!).


Interesting. Have read quite a bit about the construction, keen that it's approved and trading! It's a far cry from being "XIV-like" imo though.

only 25% instead of 100% like XIV.

It took more than 3 years for this charge and cease and desist to manifest … swift justice and decisive action at work.

Lots of people mentioning the implications to XIV ETF. But i think more about the implications to index calculators. Basically it's a bad business to be in and there's no real value in doing so... That's the lesson to be learned here. The SEC got rid of the iopv for ETFs 2 years ago... At the behest of the industry. But ultimately the lack of transparency, even if it's temporarily wrong, is a net negative for the little guy.

Edit: there's so much weirdness in this story. This is the first time I think the SEC has clamped down on a realtime index calculation agent. Also, why would the SEC go after them and not CS ... they're the ones responsible for selling securities to the general public.

Matt Levine provided context for anyone, like me, who have no idea what this is about:


XIV is an inverse of the CBOE volatility index? So you could think of it as a "stability" index ETN?

How different is a stability index from an index like S&P 500?

Absolutely no expert, but afaik stability is not about the market going up, but closer to a measure on how much the participants in the market agrees on where it's heading. It might often mean that it's more stable when an index like S&P 500 is going up, but I don't think you can compare them.

I'm prepared to be heavily corrected by financial experts here.

Layman question: Was there any arbitrage available to financial firms during the times the VIX was stale as a result of this “feature”?

No because this feature is nothing more a feed that distributes a numeric value, it's not a financial instrument that you can trade. There are products that track the VIX that can be traded, but the price of those products deviated from the value published by the S&P.

Part of the complaint is that some people relied too much on this feed and got crushed thinking there was some arbitrage opportunity when there wasn't. Any remotely competent financial firm that trades off of the VIX calculates their own value for it.

In this case DJI specifically licensed the VIX data to Credit Suisse for the purpose of offering and listing a security - XIV. You’re right that there were (and are) other securities that track VIX or use VIX as a component calculation but what’s interesting here is the SEC’s focus on XIV specifically. It seems the language of the data license agreement (quoted and summarized in paragraph 19 of the SEC’s Order[1]) played a role in the SEC’s decision to go after S&P Dow Jones for the bad data.


Were the other products ETNs? For an ETF like SVXY, you are buying ownership of the underlying derivatives contracts. For an ETN like XIV, there is no underlying instrument, and you are buying exactly* the index value (which is why I bought XIV after the close that night, and it did not turn out well).

*) Subject to counterparty risk

Hmm, thank you. But didn’t that then create such opportunities since there was a knowledge differential between firms in the know and others (perhaps day traders)?

Why do anyone follow the dow jones? When I learned about it I was pretty surprised that it was only a handful of cherry picked company.

You're referring to the DJIA which is not the subject of this thread...

Penny stocks often have unreal bid/asks after-hours and they are completely fake... could they do something about that too?

As an example for today, look at ALPP... bid: $2.00, ask: $7.00 ... but is is messed up across the board... the real price is around $3.70

And I wish that they would also regulate cryptos because a couple of days ago the spread was $1000 on BTC so I tried to make some money but after I bought with Coinbase, they would not let me sell.

I would advise you to understand how markets work better before you get more into trading. You don't seem to understand how high bid-ask spreads indicate low liquidity, nor the risks of trying to take a position in a market condition where you have such low liquidity.

It's like driving down an icy road that's empty at night and trying to make a right turn. Sure, it might look like you can go fast because it's empty. But it's empty for a reason. And you'll figure that out when you try and take the turn and can't get any traction.

The problem is Coinbase Pro that wasn't allowing me to place sell orders while allowing me to place buy orders. I should not have talked about spread because I think it confused everyone. The actual buy price was going up and down by $1000s every few seconds.

Also, I'm just investing profits at this point so don't worry about me (IE: took out initial capital).

Why is a wide spread fake? Market makers adjust width based on market conditions, nothing wrong with that.

Regarding the CB $1000 spread, it occured due to an exchange outage I believe.

Must be another "outage" coming right now

> Regarding the CB $1000 spread, it occurred due to an exchange outage I believe.

Why would they let you buy and not sell? I bought and tried to sell and it didn't work so I bought again and tried to sell again and it still would not work... Coinbase is very manipulative so they should get regulated.

Why would you want to buy at the bid and then sell at the offer with a $1000 spread? You would lose tons of money, unless you mean you were trying to make the market at a tighter spread (instead of taking).

When I bought at $50.5K, it was going to roughly $52k every other second... easy money (if they let you sell) ... next time I will do a screencast (right now I only have a bunch of screen shots).

IE: The spread was going nuts... 1 second you could buy a bitcoin at $50k and the other you could sell it at $52k.

I have a video of the spread going nuts at a different point in time, but it wasn't this bad.

Even if it is a YC company, they need to regulate them ASAP.

That's not how spreads work, an order book can never be in cross. Orders that are in cross are matched and removed from the book.

You could buy at 52k and sell at 50k, not the other way around.

When the spread is $1k, the actual price that you can buy at changes really fast... 1 second, I could buy at $50k and the next second I could buy at $51k, AKA the last trade price.

>Coinbase is very manipulative so they should get regulated.

Ironic given that coinbase is one of the more regulated exchanges out there (the others being gemini and kraken). You can definitely go worse, eg. bitfinex or binance.

no issues with Kraken yet (but I am mostly holding XMR on that exchange)... but every time bitcoin drops quickly, I have issues with Coinbase (ever since they existed)

Binance is better than coinbase in pretty much everyway it matters (except regs I guess), but kraken and bitfinex are total shit shows.

>a couple of days ago the spread was $1000 on BTC

Are you using coinbase or coinbase pro? The former gives much worse spreads than the latter, because coinbase is acting as the counterparty. I can't be bothered to check coinbase's spread right now (captcha wall) but on coinbase pro the spread is one cent. https://i.imgur.com/uZHDy4X.png

It is Coinbase pro, and most of the time, the spread is smaller then $10, but when Bitcoin's price changes rapidly, the spread goes nuts... I have seen it greater then $1000 on 5/13/2021. Next time I do a screencast.

I am more disappointed about the TSLA situation. Leaving this company out of the SP500 until they were in the top 10 company in market cap. It was a very active decision when most people would assume the sp500 is a passive index.

[edit] For clarification, TSLA already had 4 quarters of profit in September 2020 matching sp500 profit requirements but was still left out on a very active decision. [1]

[1] https://www.bloomberg.com/news/articles/2020-09-04/tesla-fal...

Nothing worth being upset about here; stocks aren't eligible for inclusion to the S&P500 until they have a trailing 4 quarters of profit.

This is not true, it's a recommendation but it's not a requirement:


At any rate, even if it were a requirement, Tesla satisfied it at the moment that it was excluded.

Well, I'm not sure what you think you see or where you see it in that 45-page pdf. The S&P 1500 criteria are, for instance, on page 8 and refute what you're saying. On a quick glance I couldn't find the S&P 500 criteria in that, again, 45-page pdf without a page reference. Or you can look here[1] on page 2.

[1] https://www.spglobal.com/spdji/en/documents/additional-mater...

>Well, I'm not sure what you think you see or where you see it in that 45-page pdf.

It's not my responsibility nor is it even possible to find a reference to a claim that is false. If you claim that X is a requirement, I can't possibly cite a specific page that says "X is not a requirement" because it's not feasible to enumerate all things that are NOT requirements. All I can do is refer you to the list of requirements and ask you to point out which item in that list substantiates your position. That is what I've done by referencing that document which specifies the eligibility criteria and methodology and that's about the most anyone can do since it's generally not possible to prove a negative.

Now you mistakenly believe that page 8 substantiates that claim, but it doesn't. What page 8 states is the following:

>The sum of the most recent four consecutive quarters’ Generally Accepted Accounting Principles (GAAP) earnings (net income excluding discontinued operations) SHOULD be positive as SHOULD the most recent quarter.

The use of the word "should" is as a recommendation, compared to the use of the word "must" which is used for criteria that is mandatory, for example on page 6:

>The issuing company MUST have the following organizational structure and share type...

Now being that it's a suggestion instead of a mandatory requirement, one would reasonably expect there to be an example that goes against that recommendation, and of course there are plenty but for a very recent example take CZR, which was just added to the S&P 500 in March of 2021 despite not having produced a profit since 2019.


It doesn't fall under any of the exemptions either.

Wasn't this the result of the profit criterion, not an active decision?

The S&P 500 is selected by a committee vote, so every inclusion is an active decision. There are hundreds of large companies excluded from it for arbitrary reasons, including Dell, Snapchat, Square and literally hundreds of others.

Yes, the S&P 500 is an active index. Its ETFs are passive because they only track that index.

Correct. To be included in the S&P you need to be average quarterly profitable + your most recent quarter needs to be profitable.

TSLA was matching the profit criterion for a while but was left out because it was too dependent on gov incentives. Which is fine but it is an active decision. As they are not making this kind of arbitrage for other companies relying on gov interventions and gov policies as well.

Which companies?

Not OP but maybe the defense contractors? Raytheon, Lockheed, General Dynamics and I think Teledyne are in the S&P 500.

Tesla was relying on direct subsidies to customers for purchasing a Tesla. That's a little different than government contracts or massive tax breaks.

Could be, but of those only Teledyne runs any real risk of losing profitability status as a result of scheduled ends of government incentives. I'm having a hard time finding out which companies OP could be referring to.

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