U.S. stock volatility spikes; short volatility ETPs implode

NEW YORK (Reuters) - Wall Street's "fear gauge" jumped to a fresh two-and-a-half year high on Tuesday as U.S. stocks fell for a third straight day and market participants grappled with the implosion of products that bet against volatility.

The Cboe Volatility Index, better known as the VIX, is the most widely followed barometer of expected near-term volatility for the S&P 500 Index. On Tuesday, the index rose as high as 50.3, its highest since August 24, 2015, before pulling back to 24.44.

Exchange traded products (ETPs) that bet on low volatility succumbed to the surge higher in the VIX. Credit Suisse said on Tuesday it will shutter the VelocityShares Daily Inverse VIX Short-Term ETN, likely leaving holders of XIV with pennies on the dollar.

Nomura Securities will redeem its Tokyo Stock Exchange-listed S&P 500 Vix Inverse ETN after a sharp equity selloff since late last week triggered a massive loss in the product.

Proshares says its short VIX short-term futures ETF will be open for trading on Tuesday and it expects normal operations going forward.

The VIX index has more than tripled since last week as a rise in bond yields, on fears that the U.S. Federal Reserve will need to adopt a more aggressive rate hike policy as inflation picks up, roiled stocks.

The sharp rise in stock market gyrations after an extended period of calm also threatened to derail one of the most successful trading strategies over the last few years - the selling of volatility.

Months of extended calm in the stock market has made selling volatility a lucrative affair, with ETPs such as the XIV and the ProShares Short VIX Short-Term Futures ETF, attracting about $3 billion in investment.

When the VIX futures prices spike these ETPs lose value, at which time the issuers of these products could liquidate the shares.

Both of these ETPs slumped about 80 percent in after-hours trading on Monday and were halted from trading on Tuesday.

Earlier, Credit Suisse Group said it faced no material impact from the plunge overnight in the XIV product which it issued and in which it has a 32 percent stake.

(Reporting by Saqib Iqbal Ahmed; Editing by Daniel Bases and Nick Zieminski)