For the second time this year, an exchange-traded note will be redeemed by the issuing institution after the intraday indicative value declined to less than $10. According to a press release from Barclays, VZZ’s IIV dipped below the $10 level shortly before noon ET on Friday; the actual redemption date will occur on the fifth business day after the termination was triggered, meaning that those holding VZZ will get paid out by July 11.
Despite the triggering of the automatic redemption threshold, trading in VZZ remained active throughout Friday’s session. The note dipped as low as $9.68 on the day, apparently reflecting confusion over the floor on the fund created by the redemption event. It’s possible investors were engaging in “panic selling” after news of the redemption broke; those savvy enough to snap up shares below the $10 price will make a nice arbitrage profit once redemption payments are made [see How To Handle ETF Closures].
VIX In Freefall
Friday’s impressive market rally capped a stellar week for equity indexes; the S&P 500 SPDR (SPY) finished the day up more than 5% from last week’s close. As anxiety over Europe’s fiscal state dissipated throughout the week, indexes measuring volatility, such as the VIX, declined precipitously.
The VIX, often known as the “fear index,” dropped nearly 25% over the last week. That led to a huge decline in VZZ, which opened Monday at $14.55. The ETN, which debuted in late 2010, was designed to offer leveraged exposure to the S&P 500 VIX Mid-Term Futures Index TR, a benchmark that includes daily rolling long position in the fourth, fifth, sixth and seventh month VIX futures contracts. VZZ sought to offer 2x leveraged exposure to the underlying index over the life of the note (which was scheduled to mature in November 2020). But because there was no reset of the leverage offered, the effective amplification multiple changed as the value of the underlying note moved. As the VIX-related index dipped, the participation ratio climbed; by Friday, VZZ’s participation ratio was about 3.55. So when the underlying index dipped by almost 5% on Friday, VZZ tumbled by close to 15% to the $10 level (contrary to some reports, the big drop had nothing to do with the approaching automatic termination level; the relevant calculation that triggers redemption involves the indicative value of the note, and not the market price).
Leveraged VIX Exposure
Investors looking for leveraged exposure to volatility have a handful of options available to them. VelocityShares offers both a Daily 2x VIX Short Term ETN (TVIX) and Daily 2x VIX Medium Term ETN (TVIZ). Those exchange-traded notes, which are issued by Credit Suisse, reset leverage on a daily basis, meaning that the amplification factor at the beginning of each day is 2x. That methodology varies from leveraged and inverse VIX ETPs from iPath that strive to deliver leveraged results over a much longer period of time–generally at least ten years.
VelocityShares also offers the Daily Inverse VIX Short-Term ETN (XIV), which was one of the best performers during the last week as volatility plummeted. XIV gained nearly 20% over the last five sessions, which saw the VIX plunge to below 16. Since 1990, the average reading for the VIX has been just north of 20 [see Inverse VIX ETPs: Reviewing All The Options].
Disclosure: No positions at time of writing.