SVOL Just Passed A Massive Test; We’re Big Buyers

In the past, we’ve written two articles about the Simplify Volatility Premium ETF, also known as NYSEARCA:SVOL.

In our first article, we talked about the fund’s unique composition and how we prefer the ETF’s long-term outlook to other high-income instruments on offer, like QYLD and JEPQ.

In the second article, we got a bit more defensive on the fund due to macro factors, but still maintained that we liked the fund’s construction overall.

Through all of this, the big question hanging over the head of SVOL was how it would do in a VIX-spike scenario, given that the fund was only launched in mid 2021. It’s true that the fund should theoretically be hedged in scenarios like this, but building a strategy in theory and testing it live in the market are two separate things altogether. You never know what can ‘go down’ under live market conditions when it comes to levered products.

As luck would have it, Monday saw one of the largest spikes in the VIX of all time in nominal terms, where the VIX spiked more than 180% before market open from 24 to 64:

While the cause of the jump was a blowup in the Yen carry trade (not a market-ending crash) this spike did send the VIX to the highest value that the market has experienced since Covid, which means that the quickness and severity of the spike was no joke:

While others have commented that the volatility proves that the fund isn’t a good option, we think the opposite is true. SVOL did end Monday down a hefty 6%, but now, with a proper VIX-plosion under its belt, we feel more confident than ever that the fund is built to last.

Today, we’ll dive in and explain why.

SVOL’s Construction

In case you didn’t know, SVOL is a unique ETF that was designed to produce a high level of income for investors.

Right now, the fund yields about 17%, and the majority of that yield is derived from a systematic VIX futures selling strategy.

We’ve already explained how this works in practice, but here’s a quick refresher if you’re interested:

In the real world, VIX futures are almost always priced higher than the VIX itself. Visually, you can see this below, where the red line is the VIX, and the white line is the front month VIX future:

Practically speaking, it means that [SVOL] is selling futures at the white line and buying them back (letting them cash settle) at the red line. When done over and over, this produces profit when the VIX is flat or going down.

Because the VIX is mean reverting, this is what happens most of the time.

All in all, we’re happy with how this strategy has been laid out by the fund sponsors, and we feel as though it is a superior option to other high-income funds that sell calls on index positions over time.

Aside from the VIX selling strategy, the fund holds the majority of its funds in short term treasuries, which aren’t very volatile and provide additional income on top of the futures income strategy.

Finally, the fund does something unique – it purchases VIX calls to protect principal in the event that the index spikes, like it did on Monday.

SVOL’s Performance On Monday

As you may know, Monday was a wild day in the market, where the market collapsed on the back of an unwind in the Japanese Yen carry trade:

While the details of that situation lie outside the scope of this article, the result was a huge increase in the VIX overnight (before market open on Monday), as traders frantically covered their positions:

This mechanically drove up volatility, which should have caused enormous losses to SVOL. However, when this was happening, SVOL’s price action was relatively calm premarket – down, but not massively:

At the worst point, SVOL was trading down no more than -9% on Monday from Friday’s close, which indicates that the fund is very well built to handle spikes like this over time.

Prior to this drop, we’d seen estimates that a big gap up to a 40 in the VIX overnight could (in theory) cause up to a 31% drop in NAV, which thankfully didn’t happen:

It’s true that a spike up to ~40 isn’t a perfect mapping of what happened on Monday morning.

On one hand, these estimates had the VIX jumping more on a percentage basis, but on the other hand, Monday saw a larger nominal move to a higher overall VIX level. Thus, it’s a bit of a tossup as to which would be a more damaging move – the projection, or what happened in reality.

However, either way, on Monday the max drawdown from close to close was -9%, which is mercifully less than the -31% that was projected.

In other words, SVOL is even more ‘tanky’ than realized, and should navigate future spikes in volatility well due to its unique hedging mechanism.

Plus, SVOL’s NAV has been recovering this week as the VIX has done its trademark move back towards the mean:

Ultimately, we’re simply more comfortable holding a larger position in this fund now that it’s been through some paces.

Risks

That said, there are still some risks to be aware of when it comes to investing in SVOL.

Considering that the VIX tends to spike up and then come down slowly, the fund is well built to withstand the front side of a move, then profit down the backside of one.

However, if the VIX were to increase slowly over time, that’s a price pattern that could cause considerable losses for SVOL. This is because a continually increasing price of vol and VIX futures would lead to a lot of small losses on a short futures position over an expiration period, which would lead to suboptimal performance. Something like this happened in early 2024:

Fortunately, this isn’t likely to happen on a long enough time horizon to cause permanent capital impairment, as increases in risk perception are often sudden and tail-like in their movements and intensity.

That said, it’s still something to be aware of.

Summary

Taken together, SVOL just went through a trial by fire, and came out the other side relatively unscathed. Considering that this was one of the most important tests for the new fund over the last few years, we’re happy with the performance, and would feel comfortable deploying a LOT more capital into this leading income ETF going forward.

Plus, with a juicy looking 17% yield at the moment, we see fit to upgrade this high-yield vehicle back to a ‘Buy’ rating.

Stay safe out there!