Inverse VIX ETN Blowup a Big Risk for CBOE Holdings (CBOE), Two Analysts Say in Downgrades
Shares of CBOE Holdings (NASDAQ: CBOE) were pressured for the second consecutive session as Wall Street debates the fallout from the VIX spike and related plunge in several inverse VIX ETNs. Today, two large brokerage firm's downgraded the stock amid risk to profit, sending the stock down 3% to $113.46.
JPMorgan's Kenneth Worthington downgraded the stock from Overweight to Neutral saying he sees "the risk presented by massive deterioration of value in short-VIX strategies as a risk to CBOE." Worthington notes inverse ETNs like VelocityShares Daily Inverse VIX ST ETN (NYSE: XIV) and ProShares Short VIX Short-Term Futures (NYSE: SVXY) lost 90-95% of their value after the VIX more than doubled. XIV will be liquidated as a result. "Given they are key drivers of VIX Futures volume for CBOE, their loss will likely be felt," he said.
Worthington said given the value lost, they don’t see a return to inverse ETNs near term, with some regulatory risk longer term. In addition to the obvious loss of volume from the shuttering of XIV, the analyst said they see more sophisticated volatility sellers at risk of reducing exposure due to the failed near-term short-vol strategies.
Looking back at history, Worthington highlighted that pasts spike in volatility has reduced trading activity. "In 2011, in the months following a similar spike in volatility, VIX futures volumes fell ~35% (60% peak to trough which we think is less informative)," he highlighted. "VIX option trading fell about 30% in future months." While the VIX Futures complex rebounded and has been a growth driver for CBOE since, VIX option activity was muted for the rest of 2012, he notes.
The recent VIX move could also have traders shopping for a better product than shorting volatility. "If the market transitions from one where shorting volatility is the preferred strategy to one where hedging risk is dominant, VIX may be less relevant vs. SPX and CME’s E-mini," the analyst explained. "Given VIX has been such a key driver of growth for CBOE in recent years, any loss of share to CME could impact both EPS and CBOE’s valuation."
Goldman Sachs' analyst Alexander Blostein echoed the VIX risk in his downgrade today of CBOE. He said the unwinding in the VIX ETF space will weigh on one of CBOE’s biggest top-line growth engines. He highlights that VIX futures were ~12% of 2017 revenues and contributed ~40% to 2015-2017E revenue growth pro-forma for BATS.
"Notably, as of the end of January, we estimate the XIV and SVXY (short ETN products) represented over 40% of the open interest in VIX futures," Blostein said.
The firm's scenario analysis assumes a range of 20%-50% decline in VIX futures volumes from 2017 levels, which would result in $0.16-0.40 EPS impact – or 3%-9% downside to 2018 FactSet consensus estimates. The firm lowered their EPS estimates by 6% in 2018 and 11% in 2019 to reflect lower VIX futures volumes.
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