The VelocityShares Daily Inverse VIX Short-Term exchange-traded note (XIV), which had fallen roughly 85 percent in after hours trade, has been halted pending news early Tuesday. The security, issued by Credit Suisse, is supposed to give the opposite return of the Cboe Volatility index (VIX), the market's widely followed turbulence gauge.
Credit Suisse said late Monday New York time that the XIV's plunge would have no "material impact" on the Swiss bank itself. Shares of Credit Suisse slumped nearly 4 percent on Tuesday morning amid the wider sell-off in equity markets.
"The XIV ETN activity is reflective of today's market volatility," the bank said. "There is no material impact to Credit Suisse."
Other volatility-related funds, including the ProShares Short VIX Short-Term Futures (SVXY), have also fallen precipitously; that ETN was also halted Tuesday morning pending news.
The VIX rocketed over 50 Tuesday, setting the stage for another rocky day on the Street. Fears mounted Tuesday morning that Credit Suisse and other issuers could seek to liquidate the funds. Such a move could artificially drive the VIX even higher and spark another big equity sell-off, traders feared.
"That's the instrument that's going haywire," Jim Cramer said Monday during a CNBC special report, referring to the 'XIV.' "It is blowing up as we speak."
"It should put downward pressure on the stock market at the opening, should spike the VIX to 50 and then cause the market to go down," he said Monday.
As explained in the VelocityShares prospectus, the company can elect to "accelerate" any of their ETNs, liquidating them early.
"If the price of the underlying futures contracts increases by more than 80 percent in a day, it is extremely likely that the Inverse ETNs will depreciate to an Intraday Indicative Value or Closing Indicative Value equal to or less than 20 percent of the prior day's Closing Indicative Value and will be subject to acceleration," read the company prospectus. "If an Acceleration Event occurs at any time with respect to any series of the ETNs, we will have the right, and under certain circumstances as described herein the obligation, to accelerate all of the outstanding ETNs of such series."
The drop also raised fears of big losses from hedge funds and other investors unfortunate enough to be holding this security and unable to unwind it.
Larry McDonald, founder of the Bear Traps Report, warned that such a huge spike in volatility could have a cascading effect.
"Positioning in all sorts of VIX ETFs has increased 5-fold in recent years," McDonald said in an email. "Even a spike in volatility similar to August 2015, would force VIX ETFs to buy an incredulous $37 billion exposure in short-term VIX futures. Such a spike can even get more exacerbated in case liquidity dries up as the market realizes certain structures need to rush in and cover their shorts at whatever the cost."
McDonald told CNBC that the August 2015 VIX move was roughly 45 percent, while today's move was double that.
The XIV was last seen at 20.88 in postmarket trading, down 80 percent from its close at 99.
"After-hours, the VIX reached 38 and futures more than doubled—it is not clear at this point how this will reflect on various short volatility products (e.g., some volatility ETPs traded down over 50% after hours)," wrote Marko Kolanovic, J.P. Morgan's quantitative and derivative strategist, in a note to clients late Monday.
It is hard to tell who is exactly holding this short-term oriented security at this time. Filings from back in September show Credit Suisse, Deutsche Asset Management, Citadel Advisors, Flow Traders, and Two Sigma as the top holders.
Some hedge funds were caught holding the bag on this security. What they do next (or are forced to do) could determine what happens with the volatility trade and the overall market.
"Today's large increase of market volatility will clearly contribute to further outflows from systematic strategies in the days ahead (volatility targeting, risk parity, CTAs, short volatility)," added Kolanovic. "The total amount of these outflows may add to roughly $100 billion, as things stand."