Silicon Valley Bank Crisis and Trading Strategy | Quantra Classroom
Have you heard about the recent crisis of the Silicon Valley Bank? If you haven't, let us explain. The bank lost over 60% of its market capitalisation in the last week! People are worried that the fall of SVB can lead to the fall of other banks, like what happened in 2008.
What does the Silicon Valley Bank do??
They give loans to venture capital and private equity firms, which in turn invest in startups. They also give loans directly to startups, and many startups have their bank accounts with this bank.
The bank was doing really well because of the tech industry's growth in recent years! In just three years, from the end of 2019 to the end of 2022, its deposits went from $61 billion to $173 billion. That's a huge increase! To invest all this money, the bank's investment team decided to buy US treasury bonds, thinking they would get good yields for the next few years.
At the end of 2022, the bank's total assets were worth a whopping $211 billion! About 35% of that, which is $73 billion, was in loans that the bank gave out. The rest of the assets, $91 billion or 43%, were in securities, which are investments the bank planned to hold until they matured. These securities included long-term investments in US bonds.
You might think that investing in US bonds is secure, so what's the problem here?
When interest rates rise, the value of these securities falls. And that's exactly what happened. interest rates rose, and the value of the bank's securities fell, leading to a huge unrealised loss.
The bank's decision-makers had thought that the yields on these bonds wouldn't rise too much and that they would continue to get good yields for the next few years. But, as it turned out, yields increased from 1% to 3.5% for a US government 10-year bond.
When yields increase, the price of the bond decreases. This is because there is an inverse relationship between bond prices and yields. So, the bank's bond prices fell because the yields rose, which resulted in a significant unrealised loss.
So, you're wondering why SVB didn't just hold onto the securities they invested in, instead of booking a loss by selling them?
Well, let's talk about where the bank gets its money from. The bank gets money from deposits made by people, including startups and big companies. But when there was a change in the interest rate cycle, the VC and PE funds were more careful with their funding, so fewer startups received funding.
This meant many startups had to rely on previously raised funds, which were in the bank, to pay their employees. As a result, there was a rise in withdrawals at the bank.
To pay back those who wanted to withdraw their money, SVB had to sell some of the securities it had invested in. However, because the value of these securities had gone down, SVB lost money when it sold them.
This caused a lot of concern among depositors who had put their money in the bank since their deposits were often larger than the amount of money that the government protects if a bank goes out of business. They really liked SVB bank because it was customer friendly, but they were afraid they might not be able to get their money back if the bank went under.
So they started to take their money out. This is called a bank run, and it can happen when people start to panic and think that a bank might not be able to give them their money back.
When too many people tried to take their money out of the SVB at the same time, the bank didn't have enough money to give them all. This meant that the bank couldn't pay its debts and had to ask the government for help. That’s why SVB was taken over by the regulator.
What happened to Signature Bank?
Signature Bank also experienced a run on deposits similar to Silicon Valley Bank. People who had their money deposited in Signature Bank started to worry that they might not be able to access their money if the bank faced financial difficulties.
Signature Bank had a lot of uninsured deposits because it catered to private companies and also served many cryptocurrency firms. This made depositors nervous and they began making large withdrawal requests. The Federal Reserve had to step in and help rescue the bank.
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What about First Republic Bank?
First Republic Bank is also facing a similar problem, where there is a risk that a lot of people might withdraw their deposits from the bank. This is a concern for the bank because if many people withdraw their money, the bank might have to resort to more expensive ways of getting funding instead of relying on deposits. This could put pressure on the bank's profitability.
What was the impact on the markets overall?
The impact of SVB's losses on overall markets was negative, and the S&P500 fell by 2.7% in the past five days. This has caused concerns that other banks could also be at risk, which has added to the overall market uncertainty or volatility.?
Such increased volatility can provide good trading opportunities. A general saying is “Volatility is a friend of good traders”. You can learn more about volatility and quant trading strategies using volatility from?here. You need to take a free preview and visit the first unit of the course.
One of the trading strategies is to trade a breakout strategy on VIX or any asset.?
VIX, also known as the "Fear Index", is a measure of market volatility or how much the stock market is expected to move up or down over a certain period of time. It is calculated based on the prices of options contracts on the S&P 500 index.?
When the stock market is expected to move a lot, VIX goes up, and when the market is expected to be calm, VIX goes down. VIX is an important tool for investors to manage risk and hedge their portfolios in volatile market conditions.
What is the breakout strategy using Bollinger bands?
This strategy is a breakout strategy that aims to identify potential buying opportunities when an asset's price breaks out above the upper Bollinger band. The long entry is confirmed when the asset enters the Bollinger expansion phase, which means that the bandwidth increases and the middle band trends higher.
To enter a long position, the following conditions should be met:
To exit a long position, you can use the middle band or multiples of the Average True Range (ATR) as a stop-loss. For the take profit, you can either use multiples of the ATR or close the long position when the Bollinger contraction phase is identified.
This phase is characterized by the upper band trending lower, the lower band trending higher, and a sharp decline in bandwidth. The python code for this strategy is available?here. You need to take the free preview to access the code.
A more advanced strategy is to trade the spread between the VIXY and VIXM ETFs.?
VIXY is a short-term ETF that aims to track the VIX index for one month. It is designed for traders who want to take advantage of short-term market volatility. VIXY is more volatile than VIXM because it tracks the VIX index more closely in the short term.
VIXM, on the other hand, is a medium-term ETF that aims to track the VIX index for five months. It is designed for investors who want to protect their portfolios against medium-term market volatility. VIXM is less volatile than VIXY because it spreads out its tracking of the VIX index over a longer period of time.
The deviation between the prices of the two ETFs can be used to create a long-short trading strategy. You buy one and sell the other, depending on the deviation in the spread and the risk appetite. You can learn more about this strategy here.
It's important to keep in mind that these strategies involve a higher level of risk and may not be suitable for everyone.
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