VXX Upside vs. Downside Risk with No New Creation Units

One week ago, Barclays announced the suspension of issuance of new creation units as well as sales from inventory for two of its ETNs: the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX); and the iPath Pure Beta Crude Oil ETN (OIL). 

The purpose of this post is to explain the risks for both long and short holders of VXX and to get a sense of how this story is likely to play out.

First of all, the announcement came before regular trading hours on March 14^th and during the entire session, VXX traded at a premium of up to 3.28 points relative to its intraday indicative value (IV), as captured in a graphic in Barclays Suspends Creation Units for VXX.  By the end of the day, VXX was trading at a 1.73 point premium to indicative value -- which is what VXX would be trading at if new creation units were still enabled.

It wasn’t until March 15^th that the fireworks begin.  That morning, VXX opened up another 2.08 points at 30.89, up 6.7% from the previous day’s close.  Right from the open there was some intense buying pressure that resulted in a short squeeze, with VXX briefly spiking as high as 41.65, up 44.6% from the previous day’s close.  That short squeeze was retraced over the course of the day and by the end of the session, VXX was down 0.11 on the day.  The action during the last five days has been relatively uneventful, though the volume in VXX has dropped approximately 90% from a pre-suspension average of about 50 million shares per day to less than 5 million today.  As of today’s close, VXX was at 25.44, some 3.93 points (15.4%) over indicative value.

The chart below captures the journey of VXX relative to indicative value (VXX.IV) in the seven days going back to the original announcement of the suspension of new creation units.  Note that for the last week, the VXX premium relative to VXX.IV has been in a range between 1.50 and 5.00, with that early short squeeze premium of 15.11 now firmly in the rear-view mirror.  At various times it appeared that traders had settled on 3.50 or 4.00 as an appropriate amount of premium for VXX in the absence of new creation units that could be used to arbitrage the price of VXX back down to VXX.IV.

The big questions are what to expect going forward and what are the risks to both long and short holders of VXX.  At the risk of stating the obvious, nobody outside of Barclays knows what will happen going forward, but Barclays described their move as a temporary suspension of creation units.  With VXX having assets of $729 million and a fee of 0.89% per year, Barclays has an incentive to find a solution for the creation units problem – and whatever is behind it – so that they can collect their $6.5 million annual fee from this product.  Credit Suisse was able to resolve a similar problem with the suspension TVIX new creation units in a month and a day back in 2012.  Barclays and VXX have been at this game longer than anyone else, with an initial launch of VXX back on January 30, 2009.  They have had 13 years to prepare for the present situation, which is likely a least partly related to hedging risks and costs associated with how Vladimir Putin proceeds with the invasion of Ukraine.  I expect they will find a solution to the new creation units problem in relatively short order, but I have no insight into whether this will be a matter of days or weeks.

Going forward, both longs and shorts have to expect that Barclays will bring VXX creation units back and when they do, the VXX premium relative to VXX.IV is likely to disappear almost instantly.  Truth be told, when Credit Suisse brought back creation units in TVIX back in 2012, it took two days for most of the indicative value premium to be wiped out, but those days were excruciating losses of 29.3% and 29.8% that left investors reeling and confused.  This time around the premium at risk of another new creation units air pocket is “only” 15.4% -- but there is very little to prevent this number from growing much larger.

This brings us to the other side of the equation.  How much higher can a short squeeze take VXX?  While 90% of the daily volume in VXX has evaporated in the past seven days, the current 5 million shares per day will likely have to shrink considerably more before a short squeeze has much in the way of potential staying power.  The DGAZ story from 2020 is a stark reminder that not only is it theoretically possible to see a spike of 12,000%, but such a spike has recently happened.  The problem for longs is that in waiting for a potential short squeeze, each day brings them one day closer to the seemingly inevitable announcement of a restoration of creation units and a 15.4% contraction in the price of VXX.  In addition to that potential 15.4% haircut, long holders should also keep in mind that VXX has lost an average of 56% per year going back to 2009 due to structural weaknesses such as contango, negative roll yield and daily compounding decay (which I have summarized in posts such as Four Key Drivers of the Price of TVIX), so time is not on the side of VXX longs.

In summary, the risk for shorts is the potential for a successful short squeeze along the lines of the DGAZ fiasco.  As volume in VXX decreases, which is likely to be the case until Barclays resolves the new creation units issue, the risk of a short squeeze rises.  On the other hand, the risk for longs is the resumption of new creation units almost immediately wiping out the premium over indicative value.  Both longs and shorts are likely to see their risks go up over time.  For VXX short, the assumption is that volume will continue to go down over time, increasing the risk of a short squeeze.  For VXX longs, the risk is that a solution to the creation units problem is just around the corner and could be announced at any time.  An announcement is unlikely to come out during the trading day, but overnight risk should be treated as considerably higher than intraday risk.

This situation is exactly the type of “jump risk” (or gap risk) that makes options an attractive way to structure a trade – either on the long or short side.  That said, note that implied volatility in VXX options is presently at an elevated level of 102, making outright purchases of VXX puts and calls expensive in the current environment.

I should note that VXX long holders may also be subject to acceleration risk, which means that this product is subject to early redemption or an “accelerated” maturity date, at which point the ETN would be redeemed at indicative value (VXX.IV) not at the current market price.  For more information on the risks associated with ETNs, FINRA has a good summary of the issues.

Last but not least, I should mention that the OIL ETN that had its creation units halted at the same time as VXX has seen very little in the way of premium over indicative value, with the biggest exception being a smaller squeeze/spike on the second day that coincided with the big spike in VXX.  Right now, the premium in OIL is a mere 0.03.  This does not mean that the Reddit wallstreetbets crowd will not suddenly pile into the OIL trade in an effort to squeeze the shorts in a lower volume name, but so far at least, the WSB crowd does not see OIL in the same way they saw the VXX or Opportunity of a Lifetime trade.

So, whether you are long or short VXX, understand the risks associated with your position and the time and volume factors also at work.  For those who insist on trading this name, consider structuring positions as defined-risk options trades.

In the graphic below, I show the premium of VXX to VXX.IV over the course of the last seven days, using 30-minute bars.

[source(s):  Yahoo, TD Ameritrade, VIX and More]

Further Reading:
Barclays Suspends Creation Units for VXX
Attempt at TVIX Short Squeeze Fizzling Out
The Resurrection of TVIX
TVIX Premium to Indicative Value Creeping Back Up
TVIX Creation Units Return; What It Means for Investors
Is TVIX Now Just a More Docile UVXY?
Recent TVIX Volume and VIX Futures Volume
The Story of VIX ETPs Relative to their Intraday Indicative Values
The Ups and Downs of the New Premium in TVIX
Credit Suisse Suspends Creation Units in TVIX: What it Means
Four Key Drivers of the Price of TVIX
Will TVIX Go to Zero?
TVIX Topples VXX as Highest Volume VIX ETP
Who Is Trading TVIX?
Volatility Becomes Unhinged on Friday
TVIX Finally Getting Its Due As Day Trading Rocket Fuel
TVIX Trades One Million Shares for First Time
All About UVXY

While it has not been updated in a while, new readers may also enjoy older posts that have been tagged with the Hall of Fame label.

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): net short VXX at time of writing

Barclays Suspends Creation Units for VXX

 Earlier today, Barclays announced the suspension of issuance of new creation units as well as sales from inventory for two of its ETNs: the iPath Series B S&P 500® VIX Short-Term Futures ETN (VXX); and the iPath Pure Beta Crude Oil ETN (OIL).  VXX is the premier VIX-based ETP and has been the most popular subject on this blog for the past 13 years.  It was the first VIX ETP to launch back on January 30, 2009 (along with VXZ) and remains the flagship product in the volatility space, averaging 70 million shares traded per day and regularly placing among the top five ETPs in terms of both share volume and options volume.

While the news from Barclays was a surprise, it was not unprecedented.  Credit Suisse suspended creation units in TVIX (a +2x version of VXX) twice: once in dramatic fashion in February 2012; and again in July 2020, when the product was delisted and moved to the pink sheets to trade under the TVIXF ticker.

The first time around, on February 21, 2012, there was not a VIX spike, per se, that triggered the event.  Instead, it was the general popularity of the product and the size of holdings in the TVIX note (ETNs are an unsecured debt note) that concerned the bank.  Credit Suisse acknowledged that the TVIX note violated the bank’s risk management rules related to the “internal limits on the size of the ETNs” and thus triggered the suspension of creation units.

The second time around, on July 12, 2020, the record volatility spike associated with the onset of the pandemic caused the size of the TVIX note to be roughly half of the size of the bank.  As a result, Credit Suisse concluded that the risk of continuing with this product was too high, so they decided to exit the ETN business, stop issuing new creation units and delist nine ETNs.

In both 2012 and 2020, the absence of new creation units led to a supply shortage and a large premium in the market price relative to the intraday indicative value (IV).  In 2012, new creation units were halted for a month and a day, with the price of TVIX rising to an 89% premium to TVIX.IV at one point.  When TVIX creation units were restored, TVIX fell 60% in three days and soon was trading within 1% of indicative value.  In 2020, the cessation of new creation units was final and irreversible, so TVIXF has now been trading on the pink sheets for 21 months without any new creation units.  Initially, there was almost no premium in TVIXF to TVIX.IV, but the Reddit r/wallstreetbets crowd eventually latched onto the potential for a short squeeze in TVIX in early February 2021 and spiked the price of TVIXF from parity to a 43% premium in two days.  Since the initial targeting by r/wallstreetbets, the premium in TVIXF to TVIX.IV has averaged about 72% and has been as high as 160% at one point.

An even more famous and noteworthy example of investors targeting a product with no creation unit capabilities for a short squeeze is the plight of the VelocityShares Daily 3x Inverse Natural Gas ETN (DGAZF), which spiked from 400 to 24,000 in a week in August 2020.  The VelocityShares Daily 3x Inverse Natural Gas ETN was traded under the ticker DGAZ when it delisted, with no new creation units along with TVIX on July 12, 2020.  The combination of longs targeting a short squeeze, limited liquidity in the OTC pink sheets, no new creation units and 3x leverage made for a historic spike of 12,000% in one week.  While such a scenario is unlikely to unfold in VXX, it is important to understand the history and the potential for outsized short squeezes when there are no creation units available to arbitrage away the difference between the heavily shorted underlying and its indicative value.

There are many other examples of ETPs that have had their creation units suspended, with resultant price anomalies.  Deutsche Bank did it with a variety of commodities ETNs in 2011 and 2012.  PowerShares also suspended creation units in the popular PowerShares DB Oil Fund (DBO) in 2015, with yet another large price spike.

While buyer beware is a good mantra to keep in mind when purchasing ETFs or particularly ETNs, it is even more important for short sellers to understand the risks of holding one or more of these products short when creation units are suspended and particularly when the products are delisted, with trading moving to the OTC pink sheets.

As for VXX, the reasons for the halt in creation units are not exactly clear.  Barclays says in their press release:

“This suspension is being imposed because Barclays does not currently have sufficient issuance capacity to support further sales from inventory and any further issuances of the ETNs. These actions are not the result of the crisis in Ukraine or any issue with the market dynamics in the underlying index components. Barclays expects to reopen sales and issuances of the ETNs as soon as it can accommodate additional capacity for future issuances.”

The underlying cause of the issuance capacity issue may be a number of factors, including the cost of hedging the position, exchange position limits or other factors.  Without knowing the underlying cause, it is difficult to predict when new creation units will be restored.  That said, as VXX appreciates in price, the size of the problem Barclays needs to tackle will continue to rise, which may further complicate the resolution process.

Of course, when new creation units are restored, one can expect that the price of VXX will almost immediately fall to that of VXX.IV.  Investors, therefore, need to understand the risks associated with long positions going forward and not find themselves in an air pocket like TVIX longs did back in March 2012.  For this reason, anyone who is insistent upon holding a long or short position in VXX should consider constructing a defined-risk position using options.  Alternatively, VIXY is an ETP issued by ProShares that holds a basket of VIX futures rather than an unsecured bank note with a promise to return the same performance as that basket of VIX futures.

It should go without saying that everything here I addressed relative to VXX is true for OIL as well and with all the turmoil in the oil markets related to events in Ukraine and Russia, there is already the potential for huge moves in the underlying.

I covered the TVIX creation units issue in considerable detail in 2012 and the links below probably provide the most comprehensive review of this matter anywhere on the internet.  I have also provided links to a number of tangential issues related to VIX ETPs and pricing anomalies.

In the graphic below, I show the divergence between VXX and VXX.IV during today’s regular trading hours (Pacific Time).  I find it interesting that it took more than three hours after the initial press release before VXX began to uncouple from VXX.IV and spike higher, ultimately reaching a 12% premium before the divergence began to narrow during the last half hour of trading.

Long-term, I still think VXX is likely to remain the premier VIX-based ETP, but Barclays has some work to do to get the creation units back and the product trading with a normal supply-demand balance.  Until then, keep a close eye on the varying premium of VXX and VXX.IV, while evaluating alternatives such as VIXY and UVXY.

[source(s):  Yahoo, TD Ameritrade, VIX and More]

Further Reading:

Attempt at TVIX Short Squeeze Fizzling Out
The Resurrection of TVIX
TVIX Premium to Indicative Value Creeping Back Up
TVIX Creation Units Return; What It Means for Investors
Is TVIX Now Just a More Docile UVXY?
Recent TVIX Volume and VIX Futures Volume
The Story of VIX ETPs Relative to their Intraday Indicative Values
The Ups and Downs of the New Premium in TVIX
Credit Suisse Suspends Creation Units in TVIX: What it Means
Four Key Drivers of the Price of TVIX
Will TVIX Go to Zero?
TVIX Topples VXX as Highest Volume VIX ETP
Who Is Trading TVIX?
Volatility Becomes Unhinged on Friday
TVIX Finally Getting Its Due As Day Trading Rocket Fuel
TVIX Trades One Million Shares for First Time
All About UVXY

For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): long VXX at time of writing