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Bloomberg reports Volatility Jump Has Traders Asking About VIX Note Poison Pill.

The Cboe Volatility Index’s biggest rally ever is raising thorny questions about the future of exchange-traded products tied to the gauge.

An ETP meant to mirror moves in the front of the VIX’s futures curve plunged more than 75 percent in after-hours trading following an 80 percent spike in contracts that comprise its underlying index during the trading day, potentially putting in play triggers that would enable the fund’s owners to liquidate it to avoid losses.

The surge in volatility has already claimed one victim: Nomura Europe Finance announced the early redemption of its Next Notes S&P 500 VIX Short-Term Futures Inverse Daily Excess Return Index ETN, which had 32.4 billion yen (approximately $300 million) in assets.

Trading was halted in VelocityShares Daily Inverse VIX Short-Term ETN, which trades under XIV, according to a market statement Tuesday.

“If they lose more than 80 percent of their value, the sponsor has the right to liquidate and they should, or they take on the risk. Thus if Bloomberg’s indicative value is correct, they are due to be liquidated,” Michael O’Rourke, chief market strategist at JonesTrading, said.

The fund, the VelocityShares Daily Inverse VIX Short-Term ETN, has been wildly popular in the past year as volatility on American equity markets sank to historic lows, delivering an eye-popping return of more than 187 percent last year. It pulled in nearly $1 billion in just the first five weeks of this year, while the VelocityShares Daily Inverse VIX Short-Term ETN (ticker XIV) has added almost $750 million over the same time frame.

The S&P futures put in a wild ride this evening with multiple swings in both directions. The S&P is up 100 points from the low, in the green by 10 points as I type at 5:00 AM Central. The VIX is near 44.

Expect more announcements soon.

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Mike "Mish" Shedlock