Three New Risk Control ETFs from Direxion

Today Direxion announced they have launched three ETFs whose intent is to match their exposure to an underlying equity index based upon current levels of market volatility. The new ETFs are as follows:

• Direxion S&P 500 RC Volatility Response Shares (VSPY)
• Direxion S&P 1500 RC Volatility Response Shares (VSPR)
• Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT)

The launch of these ETFs expands Direxion’s stable of what they call “rules-based index ETFs,” which began with two ETFs that are based on insider trading data: INSD and KNOW. The three new ETFs also arrive just five days after S&P announced a new S&P Dynamic Rebalancing Risk Control Index Series, which provides the basis for evaluating volatility and matching equity exposure to anticipated risk.

The intent of these ETFs is spelled out by Direxion:

“The Funds embody a rules-based investment approach that uses volatility as a gauge to determine equity exposure. They operate according to the principle that exposure to equities should be reduced during periods of higher overall market volatility, and increased during periods of a more stable (lower volatility) market environment. Each Fund has a target volatility level for its corresponding index. When volatility moves above those levels, the Funds will increase their exposure to U.S. Treasuries and decrease their exposure to equities. The Funds will proportionately increase exposure to equities during periods of low market volatility.”

Readers with sharp memories may recall that back in July 2010, Direxion was the first ETF provider to announce that they would be launching a product based on the S&P 500 Dynamic VEQTOR Index, which was an effort to mitigate risk with a dynamic allocation of VIX short-term futures, essentially the equivalent of sizing a VXX hedge based on observed levels of implied volatility and historical volatility. I am not sure why Direxion’s VEQTOR product never saw the light of day, but Barclays ended up with one of the few successful VIX ETPs in 2011 (see VIX Exchange-Traded Products: The Year in Review, 2011) with its Barclays ETN+ S&P VEQTOR ETN (VQT) product, which I made a strong case for back in October 2010 in The Case for VQT.

One of the interesting aspects of the approach taken by VSPY, VSPR and VLAT is that these products will tend to have minimum exposure when the VIX is at its highest – and as anyone who has ever looked a chart of the VIX and SPX/SPY knows, this is typically when stocks bottom and begin a sharp bullish move.

With impeccable timing, EconomPic Data just happened to publish a study yesterday, VIX as a Predictor of Equity Returns, which concluded that for the most part, SPY daily returns were much higher with an elevated VIX than with a historically low VIX.

All this raises the question of how to play increased volatility and risk. In the land of ETPs, there are quite a few alternatives, including:

• Barclays ETN+ S&P VEQTOR ETN (VQT) – dynamically hedge with a long VIX futures position
• Direxion’s VSPY and VSPR to dynamically adjust exposure to equities
• PowerShares low volatility (SPLV) and high beta (SPHB) approaches for manual market timing
• ETRACS Fisher-Gartman Risk On ETN (ONN) and ETRACS Fisher-Gartman Risk Off ETN (OFF) – for those who wish to manually time the multi-asset class risk on/risk off trade

Investors who believe they are more adept at timing the market may prefer to avoid the rules-based products that dynamically adjust exposure based on a static risk measurement mechanism. For those who prefer not to watch their portfolio closely or are not convinced that they can do a better job than the likes of VQT, VSPY and perhaps SPLV, the new category of dynamic risk exposure products should provide some excellent tools for portfolio augmentation and in some cases, portfolio replacement.

Related posts:

• VIX Exchange-Traded Products: The Year in Review, 2011
• High and Low Volatility ETPs
• Slicing and Dicing All 31 Flavors of the VIX ETPs
• Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR
• Barclays VEQTOR ETN (VQT) Begins Trading
• The Case for VQT

Disclosure(s): short VXX at time of writing

The Case for VQT

Many investors, present company included, are sitting on sizeable gains from long positions going back as far as March 2009. With the S&P 500 up 16% from its recent July 1^st low of 1010 and looking like it may take another run at 1200 sometime soon, longs are torn between the desire to lock in some profits on the one hand and have the potential to benefit from further upside on the other hand.

While there are a number of ways to approach this problem, a new off-the-shelf strategy became available with the launch of Barclays ETN+ S&P VEQTOR ETN (VQT) on September 1^st.

To briefly recap, VQT is essentially a portfolio with two components: a long SPY component and a long VXX component. At the end of each day, the ETN evaluates volatility risk and based upon rules which incorporate realized volatility and implied volatility, determines how much the SPY positions should be hedged with VXX. The result is a dynamically hedged long position that is hedged with volatility. The SPY component of VQT is set to vary in a range of 60-97.5%, with the VXX component comprising the balance of the VQT at anywhere from 2.5-40%.  VQT also has another intriguing portfolio allocation feature that none of the other volatility ETNs have:  a stop loss provision which overrides all other allocations.  This stop loss provision is triggered whenever VQTs 5-day return falls below -2%, at which point the ETN's portfolio automatically switches to 100% cash and remains at 100% cash until the 5-day return rises above -2%.

The chart below shows that VQT is structured not only to limit losses in an environment of increased volatility, but also profit in some high volatility scenarios.

Since VQT is perhaps the most complex actively managed ETN that is traded, I highly recommend that readers study the pricing supplement for VQT, the highlights of which I sketched out in Barclays VEQTOR ETN (VQT) Begins Trading.

Finally, I feel obliged to mention that to date VQT has only managed to trade about 5,000 shares per day, on average. While market depth is not great, the spread is consistently in the area of about 0.06 – which is not bad considering that VQT is trading over 105 as I type this. As is the case with any exotic ETN, there is no guarantee VQT will attract sufficient interest to become a permanent fixture on the investing landscape, which would be a shame, because I believe this ETN has considerable potential.

For those who think they might have an interest in this product further on down the line, I have one thought: use it or lose it!

Related posts:

• Barclays VEQTOR ETN (VQT) Begins Trading
• Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR
• Chart of the Week: Strategy-in-a-Box ETFs
• Diving a Little Deeper into Strategy-in-a-Box ETFs

 

[source: Barclays]

 

Disclosure(s): long VQT and short VXX at time of writing

Barclays VEQTOR ETN (VQT) Begins Trading

Both volatility traders and long-term investors should be interested to know that Barclays launched the launched the ETN+ S&P VEQTOR ETN (VQT) yesterday. Flying mostly under the radar, this ETN traded only 300 shares in its first day. That being said, I think VQT is probably the most interesting volatility product launched to date, with dynamic hedging rules that make it the first actively managed off-the-shelf volatility product for the retail investor.

I promise a more detailed analysis of VQT in the near future, but for now suffice it to say that the ETN essentially consists of a long position in the S&P 500 index, hedged with a volatility position (VXX) that varies daily, based on how the ETN evaluates volatility risk, largely using realized volatility and implied volatility calculations. The table below shows that the two main inputs into determining the VXX allocation are the current level of realized volatility and the direction of the implied volatility trend. The equity component of VQT is set to vary in a range of 60-97.5%, with the volatility component comprising the balance of the VQT at anywhere from 2.5-40%.

The concept behind VQT is an extremely attractive one, as it includes some built-in disaster insurance in the form not just of a volatility hedge, but also a stop loss feature, which is triggered whenever the 5-day return of the VEQTOR index on which VQT is based is equal to or less than -2.0%.

The specific implementation of volatility rules deserves more detailed treatment, which I will take up in subsequent posts. In the meantime, readers are encouraged to study the pricing supplement for VQT.

Note that VQT bears an extremely strong resemblance to a forthcoming VEQTOR product from Direxion that I discussed a little over a month ago in Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR.

Related posts:

• Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR
• Chart of the Week: Strategy-in-a-Box ETFs
• Diving a Little Deeper into Strategy-in-a-Box ETFs

[source: Barclays]

Disclosure(s): neutral position in VXX via options

Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR

As the ETF space continues to evolve and push into new territory, such as strategy-in-a-box ETFs and more actively managed ETFs (e.g., QAI, ALT, PQY, PQZ, GVT, PSR, RWG), it was only a matter of time before a volatility play was added to the pool of actively managed ETFs.

Credit Direxion with being the first to venture into the realm of actively managed ETFs with a strong volatility component. In a recent SEC filing, Direxion unveiled plans to launch an intriguing new ETF under the name of S&P 500 Dynamic VEQTOR Shares. This ETF will seek to track the S&P 500 Dynamic VEQTOR Index, which was launched by S&P back on November 18, 2009.

So far, so good.

Here is where it gets interesting. The VEQTOR index (and ETF) have three components: equity (S&P 500); volatility (S&P 500 Short-Term VIX Futures Index, aka VXX) and cash. Based upon several rules and formulas, the index attempts to derive – on a daily basis – the ideal target volatility allocation. This is accomplished by evaluating realized volatility and implied volatility, determining the implied volatility trend (using 5-day and 20-day IV moving averages) and arriving at a target index volatility allocation based on realized volatility and implied volatility data. Once the target volatility allocation has been determined (the range is from 2.5% to 40.0%), the balance of the index is populated with the S&P 500.

Just to make things more interesting, the VEQTOR index also has a stop loss provision which specifies that if aggregate losses during any five day business period are 2% or higher, the index will move into a 100% cash position.

When the VEQTOR ETF is launched, I will have a lot more to say about this fascinating product. In the meantime, those interested in additional information on the VEQTOR index and ETF should try:

• S&P 500 Dynamic VEQTOR Index - Splash Page
  
• Direxion Shares ETF Trust II S-1 Form SEC Filing (covers 11 different ETFs)
  

For more on related subjects, readers are encouraged to check out:

• Chart of the Week: Strategy-in-a-Box ETFs
• Diving a Little Deeper into Strategy-in-a-Box ETFs

Disclosure(s): neutral position on VXX via options at time of writing