VelocityShares, a new firm run by former iPath executives, made its initial foray into the ETP industry on Tuesday by rolling out six notes linked to various VIX-related indexes. The new products include both funds that will go head-to-head with existing iPath ETNs as well as several first-to-market products, including funds offering daily leveraged exposure to benchmarks comprised of VIX futures contracts. The new VelocityShares offerings include the Inverse VIX Short Term ETN (XIV), Inverse VIX Medium Term ETN (ZIV), 2x Long VIX Short Term ETN (TVIX), 2x Long VIX Medium Term ETN (TVIZ), VIX Short Term ETN (VIIX), and VIX Medium Term ETN (VIIZ). Each of the new ETNs is a debt security issued by Credit Suisse.
The CBOE Market Volatility Index, better known as the VIX, has long been a widely-followed benchmark used to gauge the market’s expectations for volatility in stock markets over the next 30 days. The index is calculated using a blend of prices for options written on the S&P 500, meaning that it isn’t possible to invest directly in the “fear index.” In 2004, the first futures contracts linked to the VIX began trading on the CBOE, and two years later options were introduced as well. In early 2009, iPath rolled out two exchange-traded notes linked to indexes comprised of VIX futures, making the exotic asset class available to a wider range of investors.
Interest in volatility products has surged in recent years, as investors have embraced these funds as a way to hedge equity market exposure or bet on a dip in stock prices. The VIX generally exhibits a strong negative correlation with equity markets, since rising expectations for volatility tend to coincide with an increase in anxiety over the global economic outlook.
Like their established counterparts, the VelocityShares products won’t offer direct exposure to the VIX, but rather to an index consisting of futures contracts linked to the VIX. Because the market for VIX futures is often in steep contango–meaning that longer-dated contracts are more expensive than those nearing expiration–futures-based strategies generally lag behind a hypothetical return on the spot 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. Additionally, it is also important to note that short-term indexes tend to be much more volatile than the corresponding funds tracking longer sections of the curve [see New Firm Plans Inverse, Leveraged VIX ETNs].
The VelocityShares products are designed with sophisticated traders in mind, seeking to tap into the market of traders looking to hedge equity positions or make short term bets on market volatility. In a recent SEC filing, the company noted that its leveraged products, which reset on a daily basis, “are intended to be trading tools for sophisticated investors to manage daily trading risks” and “may not be suitable for investors who plan to hold them for longer than one day.”
An Increasingly Crowded Market
In addition to this offering from VelocityShares, Citigroup recently unveiled a volatility ETN of its own that has generated considerable early interest among investors. And Jefferies has laid the groundwork for a first-of-its-kind ETF that seeks to replicate a volatility index. So a section of the ETF world that didn’t exist at the beginning of 2009 is now growing like a weed, with investors racing to provide various options for exposure to the previously hard-to-reach asset class [read Using ETFs As "Portfolio Insurance"].
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Disclosure: No positions at time of writing.
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