VelocityShares, a newcomer to the ETF industry, is planning to jump into the world of volatility exchange-traded notes, recently detailing six new ETNs designed primarily for short-term sophisticated investors. The notes, which will be issued by Credit Suisse, will include 1x, -1x, and 2x versions linked to both the S&P 500 VIX Short-Term Futures Index and S&P 500 VIX Mid-Term Futures Index:
|Inverse VIX Short Term ETN||S&P 500 VIX Short-Term Futures Index||-100%||XIV|
|Long VIX Short Term ETN||S&P 500 VIX Short-Term Futures Index||100%||VIIX|
|2x Long VIX Short Term ETN||S&P 500 VIX Short-Term Futures Index||200%||TVIX|
|Inverse VIX Medium Term ETN||S&P 500 VIX Mid-Term Futures Index||-100%||ZIV|
|Long VIX Medium Term ETN||S&P 500 VIX Mid-Term Futures Index||100%||VIIZ|
|2x Long VIX Medium Term ETN||S&P 500 VIX Mid-Term Futures Index||200%||TVIZ|
The CBOE Volatility Index, better known as the “VIX” and sometimes dubbed the “fear index,” measures the market price of volatility in large cap U.S. equities over the next 30 days. The index is calculated based on prices of certain put and call options on the S&P 500 Index. When investors are expecting significant short-term market volatility, the VIX generally rises. During less turbulent times, the VIX tends to decline. After surging to more than 80 during the recent recession, the VIX has steadily declined to near its long-term average of 20. Because the VIX tends to spike when anxiety is running high, it exhibits an extremely strong negative correlation with both domestic and international equity markets [see Using ETFs As Portfolio Insurance].
Like existing VIX ETNs, the proposed VelocityShares products wouldn’t offer direct exposure to the VIX, but rather to an index consisting of futures contracts linked to the VIX. The short-term index is comprised of first and second month futures contracts, while the mid term index measures the return of a rolling long position in the fourth, fifth, sixth, and seventh month VIX futures contracts. Generally, investments in VIX futures contracts will exhibit less volatility than a hypothetical investment in the spot VIX.
Just as the ETF boom has made commodity exposure widely available to all types of investors, so too has it democratized volatility as an asset class. There are currently four products in the Volatility ETFdb Category, including three from iPath with which the proposed VelocityShares products would compete directly. VXX, which is linked to an index comprised of short-term VIX futures, currently has more than $1.7 billion in assets. VXZ, which is linked to the same mid-term benchmark as the proposed VIIZ, has about $500 million. iPath also recently rolled out an inverse VIX ETN (XXV) that has about $50 million in assets [see The Ultimate Deflation-Fighting ETF].
While iPath is the dominant player in the VIX ETN space, a number of other issuers are stepping up the competition. Citigroup recently unveiled its own volatility product (CVOL), which is linked to the Citi Volatility Total Return Index. Jefferies, the ETF issuer best known for ETFs comprised of commodity-intensive equities, has filed for SEC approval on what would be the first ETF that seeks to replicate a volatility index (all existing products are structured as exchange-traded notes).
Built For Traders
The casual investor doesn’t seem to be the target audience for VelocityShares. In the recent SEC filing, the company noted that the proposed ETNs, including the 2x long ETNs in particular, are “intended to be trading tools for sophisticated investors to manage daily trading risks.” The filing also noted that the volatility ETNs “should be purchased only by knowledgeable investors who understand the potential consequences of investing in volatility indices and of seeking inverse or leveraged investment result.” [see Technical Trading Ideas: VXX]
Because the market for volatility futures is often in steep contango, securities linked to the VIX or other measures of volatility haven’t performed well for those investors who buy and hold. Through the first ten months of the year, VXX had lost more than 60% of its value; during that same period the VIX had declined by only about 2%, highlighting the potential for returns to futures-based products to be eroded by upward-sloping futures curves.
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Disclosure: No positions at time of writing.