iPath, one of the largest issuer of ETNs, recently debuted a new volatility product designed to shift exposure to various VIX-linked indexed based on market conditions. The new S&P 500 Dynamic VIX ETN (XVZ) is designed to dynamically allocate between the S&P 500 VIX Short-Term Futures Index Excess Return and the S&P 500 VIX Mid-Term Futures Index Excess Return depending on the steepness of the implied volatility curve. The short-term index consists of a daily rolling position in first and second month VIX futures contracts, while the mid-term benchmark consists of a rolling position in fourth, fifth, sixth, and seventh month VIX futures contracts. The allocation between those two indexes is based on predetermined ruled related to the calculated implied volatility term structure–essentially a measure of the degree of contango or backwardation in VIX futures markets. According to the prospectus, the allocations to the short-term index will range from -30% to 50%, while the allocation to the min-term index will range from 50% to 100%. As of Thursday, the ETN was allocated 75% to the mid-term index with the remainder to the short-term benchmark.
Access to volatility is a relatively new innovation, and the rise in popularity in the asset class is attributable in large part to the development of exchange-traded products that offer relatively cheap and efficient exposure. Interest in volatility has been surging in recent weeks, especially given the current environment for global equities. As the VIX, which measures implied short-term volatility in U.S. equity markets, has soared, the various ETNs and ETFs in the Volatility ETFdb Category have seen dramatic swings (and in some cases, big inflows).
Because a direct investment in the VIX isn’t possible–the index is calculated base on prices of various options contracts–the ETPs covering this asset class utilize futures contracts to offer exposure. As with any futures-based strategy, there exists the potential for returns generated to vary significantly from a hypothetical change in the spot index. With the present environment as a notable exception, VIX futures are generally in steep contango, especially at the short end of the curve. That means that when held for extended periods of time, many VIX ETPs can be expected to lag far behind the change in the spot VIX (and generally to incur losses). The performance of the ultra-popular VXX, which is linked to the short-term index, is a good example. Despite gaining nearly 95% over the last four weeks, VXX is still deep in negative territory over the last year.
Most VIX futures products offer exposure either to short-term VIX futures or mid-term VIX futures. The former generally exhibits greater sensitivity to changes in the spot VIX, but is also generally more vulnerable to the adverse impact of contango; mid-term futures may not move perfectly in unison with the VIX, but are often better long-term plays. The new XVZ will mix allocations to those indexes based on current market conditions, with the goal of mitigating the adverse impact of contango while still offering up exposure to the VIX [see Volatility ETFs: The Real Safe Haven?].
“As investors are increasingly looking for ways to access equity market volatility, this ETN offers them exposure while aiming to reduce the roll costs furing calm markets and potentially providing enhanced beta to the VIX Index during more volatile periods” said Eric Schlanger, Head of U.S. Flow Derivatives at Barclays Capital.
Evolution Of Volatility ETPs
XVZ is perhaps similar in nature to the various commodity ETPs that have debuted in recent years with the goal of mitigating the impact of contango on bottom line returns. It isn’t the first product with that general objective; UBS debuted the E-TRACS Daily Long-Short VIX ETN (XVIX) in late 2010. That product is linked to an index with a long position in the mid-term VIX index coupled with a partial short position in the short-term index. VelocityShares also offers an ETN designed to exploit the contango at the short end of the volatility curve; the Daily Inverse VIX Short-Term ETN (XIV) has not surprisingly been slaughtered in recent weeks as volatility has spiked.
The ETN will charge an annual expense ratio of 0.95%, in line with the average for volatility ETPs [see also Inside The 8x Leveraged ETN].
Disclosure: Photo courtesy of Tobias Maximilian Mittrach. No positions at time of writing.
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