First, let’s understand what did not happen. The now infamous, VelocityShares Inverse VIX Short Term ETN (XIV) did not malfunction; it did exactly what it was supposed to do. It dropped 90% when the Volatility Index (VIX) dropped 45%.
The problem that many people have been highlighting about the XIV is that individual retail investors should not be using this particular product as a trading vehicle. That is absolutely true but retail traders did not start the cascade of selling in the VIX. In fact, they were deliberately kept out of it.
The VIX is a tool primarily used by hedge funds and institutions, and these “market participants” don’t like to make their trades public. They find liquidity in “dark pools” which are private and unseen markets of liquidity. And they often trade after-hours or in the pre-market.
That is what happened on Monday and before the market opened on Tuesday. Undetected pre-market and post-market trading, disclosed at the open on Tuesday.
So, in my opinion it wasn’t the product that hurt the retail investor. It was the fact that a majority of the trading that took the XIV lower was done at night…behind closed doors.
The retail trader was left out of the trade until it was too late. What would Michael Lewis say?