VIX and More

Wednesday, March 7, 2012

Is TVIX Now Just a More Docile UVXY?

Today is the eleventh trading day since Credit Suisse (CS) announced a suspension of new creation units in the VelocityShares Daily 2x VIX Short-Term ETN (TVIX) after the close of the regular trading session on February 21.

In the interim, all manner of investors, pundits, industry players and members of the media have attempted to grapple with the implications of this move for TVIX, for the broader class of VIX exchange-traded products (ETPs) and even for the VIX futures market as a whole.

One of the more thought-provoking perspectives on TVIX and the VIX futures market came from Dave Nadig and Gene Koyfman of Index Universe in Volatility ETFs Own All VIX Futures, which I consider to be required reading. The potential implications of the VIX ETP tail wagging the VIX futures dog were nicely summarized by Izabella Kaminska of the Financial Times, wh0 wondered, Time for Position Limits on VIX Futures?

While I find the regulatory, exchange and internal risk management issues that have been raised by the TVIX creation units halt to be interesting fodder for contemplation, I am much more interested in understanding how the market disruptions have changed the manner in which some securities move and the trading implications of these changes.

In the graphic below, I have plotted the daily moves for TVIX, UVXY and the S&P 500 index over the course of the last ten trading days. In short, while it initially appeared as if TVIX was holding up much better than UVXY as the market declined, now it appears as if TVIX is also much more sluggish to the upside as well. While TVIX has outperformed UVXY during the last ten days, the most compelling explanation for disconnect between TVIX and UVXY is that the new market environment has substantially lowered TVIX’s beta. In other words, TVIX now lives more in the realm of (+1x) VXX than (+2x) UVXY – and much closer to VXX at that. During the last ten trading days, UVXY has a 10-day historical volatility of 117, while VXX has a 10-day historical volatility of 60. And TVIX? Well, during this period TVIX has been even more docile than VXX, with historical volatility reading of only 45.

For now at least, TVIX appears much less prone to spiking than I would have expected. This does not, however, rule out the possibility of a TVIX short squeeze sometime in the future. Buyers – and sellers – beware.

[source(s): TD Ameritrade]

Disclosure(s): short TVIX, UVXY and VXX at time of writing

Tuesday, March 6, 2012

Putting the Current 2.6% SPX Pullback in Recent Historical Context

Since the beginning of the current bull market – which bottomed at 666.79 exactly three years ago today – I have periodically been posting a table of the most significant pullbacks in the S&P 500 index since that March 2009 bottom. For the record, the current 2.6% decline over four days is barely enough to get it to qualify as one of those 16 pullbacks.

The data below incorporates intraday readings and use pullbacks from high water marks to the eventual trough as the basis for calculating the magnitude and duration of the pullbacks.

While not captured in the table, investors should probably keep in mind that the median pullback during the last three years has lasted 7 trading days and dropped the SPX a total of 5.6%. Were we to see a median pullback form this time around, it would suggest a bottom of about SPX 1301 sometime on Friday after the employment report.

Those looking for bigger numbers might be interested to know that a mean pullback would put the SPX back to the 1275-1279 range, while a ‘pullback’ that would be comparable to the May-October decline from 2011 would set the SPX back all the way to about 1080.

Disclosure(s): none

VXEEM vs. VIX Indices and Futures in Today’s Selloff

Stocks have been eerily quiet for the first ten weeks of 2012, with only four 1% moves in the SPX so far – and all of those coming to the upside.

It just so happens that the CBOE’s launch of futures and options on the CBOE Emerging Markets ETF Volatility Index (VXEEM) coincided with this period of languid volatility, which has made it easier for this index to fly under the radar.

Today is the first time I am able to get data on the VXEEM futures in a market that is down at least 1% and I must admit to being somewhat surprised by the results.

The table below captures SPY and VIX data in the left column along with and EEM and VXEEM data in the right column. Note that approximately one hour into today’s regular trading session, SPY was down about 1.3% and EEM, the popular emerging markets ETF, was down 3.1%. So far, so good. Far more interesting, while EEM was down about 2.4 times as much as SPY, the VIX was up substantially more than the VXEEM index, 16.57% to 12.62%...so while the selloff was disproportionately in emerging markets, the panic was disproportionately in the S&P 500 index.

I also captured simultaneous futures data for March, April and May for both the VIX futures and VXEEM futures. Interestingly enough, the changes in the front three month futures for both the VIX and VXEEM were almost identical.

So what kind of volatility environment do we live in where the emerging markets index falls faster than the SPX (even beta-adjusted, but that discussion is for another day), while the VIX spikes much more than VXEEM, yet the futures for both products seem to move in almost identical fashion?

If you think you have the answer, pairs trading opportunities with VIX products and the VXEEM futures and options (there are no ETPs yet that are based on VXEEM) are certainly there for the taking. While VXEEM futures and options are not particularly liquid or deep yet, they are sufficiently liquid and deep from which to extract some profits.

[source(s): Interactive Brokers]

Disclosure(s): long EEM at time of writing; the CBOE is an advertiser on VIX and More

Sunday, March 4, 2012

Volatility Indices vs. Futures

The CBOE Volatility Index, also known as the VIX, is the most famous and widely quoted of all the volatility indices. It measures the market’s expectations of the volatility in the S&P 500 index (SPX) for the next 30 calendar days. Unbeknownst to many (despite my efforts), the VIX also has a lesser known sibling that measures the volatility expectations in the SPX for the next 93 calendar days: VXV.

In addition to the volatility indices, there are also markets for VIX futures; lately these have extended out eight or nine months into the future. Whereas the VIX and VXV evaluate volatility over the full course of a future window, the VIX futures are the market’s best guess at what the VIX will be at various snapshots into the future. [The distinction is not that dissimilar to the snapshot of a balance sheet vs. the flows in an income statement or a cash flow statement in accounting.] For this reason, it is certainly possible that an index which measures volatility over the next 93 calendar days may come up with a different value than a VIX futures product in which market participants attempt to estimate what the VIX will be at a specific point in time some 93 days later.

For the most part, the relationship between the VIX and VXV (which are calculations based on the implied volatility of a strip of SPX options) and the VIX futures (whose values are based on market prices) holds together fairly well.

Lately, however, the volatility index values have been much cheaper than the futures values for comparable time periods. In the graphic below, the VIX futures term structure (or at least the first eight months of it) is represented by the blue line, while the VIX and VXV are the red dots and dotted connecting line resting substantially below the VIX futures values.

Savvy traders may be able to find ways to take advantage of this and some related price discrepancies. Everyone, however, is free to ponder the source of the disconnect between SPX options traders and VIX futures traders.

[source(s): CBOE Futures Exchange (CFE), CBOE]

Disclosure(s): the CBOE is an advertiser on VIX and More

Saturday, March 3, 2012

Recent Research Projects and Expiring Monthly

It occurred to me than in a recent post, Five Years of VIX and More, I neglected to mention my contributions to Expiring Monthly: The Option Traders Journal, where I tend to publish some of my proprietary research and analysis in a somewhat longer form (1000-4000 words) than I do in this space.

Rather than my typical screen shot of the table of contents and some brief comments on what I have been thinking about and writing for the magazine as of late, I thought that as the second year of Expiring Monthly has just concluded, it might be interesting to list all the titles of the 42 articles I have written for the magazine to give readers a sense of some of my more detailed research interests.

Accordingly, the graphic below lists all the articles I have written for Expiring Monthly in chronological order, up to and including Calculating the Future Range of the VIX, which was part of the February 2012 issue that was published last week.

I recently republished The VIX-VXX Minotaur Trade, which first appeared in the December 2010 edition of Expiring Monthly, in this space. The Education of a Trader, which also originated at Expiring Monthly in our editorial Back Page column, was republished here as well. Going forward, I think I will start pulling additional articles from the Expiring Monthly archives (perhaps 1-2 articles per year that are at least one year past publication) and see if they can find a wider audience here. Given all the recent interest in hedging, something like Cheating with Partial Hedges is certainly a candidate for finding its way onto these pages.

More information on prior issues can be found by following all the posts tagged herein with the Expiring Monthly label. For those who are interested in subscription information and additional details about the magazine, you can find all that and more at http://www.expiringmonthly.com/.

Disclosure(s): short VXX at time of writing; I am one of the founders and owners of Expiring Monthly

Friday, March 2, 2012

Dynamic VIX ETPs as Long-Term Hedges

With the huge contango in the VIX futures term structure at the moment, anyone who is buying VIX options or the VIX exchange-traded products (ETPs) right now is having to pay for that contango in order to have the opportunity to capitalize on increasing volatility. With the contango-based negative roll yield currently running at 15% per month, this means the cost of a volatility hedge for long equity positions is extremely expensive in the current market.

Fortunately, investors do have some alternatives that have a different type of appeal.

There are two VIX ETPs, VQT and XVZ, which attempt to minimize the impact of the negative roll yield by using a market timing mechanism that dynamically adjusts the long volatility exposure. In more volatile markets, the exposure increases; in less volatile markets, the long volatility exposure is either very low (in the case of VQT) or can even flip to a small net short position (in the case of XVZ).

VQT is more of a portfolio replacement strategy, while XVZ is more of a portfolio augmentation strategy. Specifically, VQT has long SPY exposure that ranges from 60% to 97.5% of its portfolio, with the balance (2.5% - 40%) allocated to a long position in the VIX short-term futures (think VXX). The links below will provide more details.

XVZ, on the other hand, does not hold any long equity component, only short-term (again, think VXX) and mid-term (think VXZ) VIX futures. The twist here is that while the mid-term VIX futures component can range from 50-100% of the portfolio, the short-term component can be as high as 50%, but as low as negative 30%. So…under certain circumstances (e.g., a very steep VIX futures term structure, like the one we are currently experiencing), the portfolio will consist of the equivalent of a 30% short position in VXX and a 70% long position in VXZ. On balance, that type of portfolio should be very close to volatility neutral and in some cases even have a slight short volatility bias.

Since XVZ was only launched on August 18, 2011 (VQT dates back to September 2010), I have chosen a graphic that shows the relative performance of the SPX (red line), VQT (blue line) and XVZ (green line) from the launch of XVZ to the present. Note that with its long exposure, VQT is better able to take advantage of a low volatility slow bull market. XVZ, on the other hand, is generally close to flat in a low volatility bull market, but should the VIX spike sharply higher, XVZ will likely do a better job of capitalizing on the volatility spike.

As investors ponder the fatigued bulls and inevitable pullback sometime in the near future, certainly VQT and XVZ warrant a more detailed investigation, along with some of the non-volatility ETPs that are meant to reduce risk and hedge against a downturn, such as VSPY, SPLV, and others.

[source(s): StockCharts.com]

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

Wednesday, February 29, 2012

Recent TVIX Volume and VIX Futures Volume

I managed to let a couple of days pass without mentioning the suddenly white-hot topic of the VelocityShares Daily 2x VIX Short-Term ETN (TVIX) only to discover at a Bloomberg Volatility Symposium in San Francisco last night that there appears to be an insatiable demand for more information on the subject. While the links below should present the lion’s share of the background and context about the key issues related to TVIX, today I am presenting some additional information related to the volume of TVIX for the first two months of 2012 and the corresponding volumes in the front month and second month VIX futures. The graphic below plots daily volume in TVIX (solid black line) on the right Y-axis and volume in the front two months of VIX futures, using settlement prices from the CBOE Futures Exchange (CFE), on the left Y-axis.

Once again I will let the graphic do most of the talking, but clearly when Credit Suisse (CS) announced a suspension of new creation units in TVIX after the close of the regular trading session on February 21, volume in both TVIX as well as the front month (dotted dark blue line) and second month (dashed medium blue line) dropped dramatically, almost in lockstep.

What it will take for the VIX futures and related markets to get to a point where Credit Suisse feels comfortable about reopening the creation units window for TVIX remains to be seen, but for now at least, the new normal in the VIX futures markets and to some extent for TVIX is beginning to resemble the old normal of two months ago.

[source(s): CBOE Futures Exchange, Yahoo]

Disclosure(s): short TVIX at time of writing

Tuesday, February 28, 2012

ETRACS Volatility ETPs

While the likes of TVIX and UVXY have become overnight sensations during the last few weeks, one group of VIX exchange-traded products (ETPs) that continues to toil in relative obscurity is the dozen ETRACS VIX ETN that UBS launched in September 2011.

The ETRACS products are simple in their conception: they are based on the VIX futures and include both long and inverse products with target weighted average maturities of 1 month, 2 months, 3 months, 4 months, 5 months and 6 months. The tickers are straightforward as well: VXAA for the 1month long product, with AAVX for the 1 month inverse product; VXBB for the 2 month long product, with BBVX for the 2 month inverse product; etc.

In essence, the ETRACS volatility products have the potential to allow investors in a standard brokerage account the ability to be long or short almost any portion of the VIX futures curve without having to trade in a futures account and deal with the additional regulatory, margin and other complexities of maintaining a futures account.

In practice, the ETRACS products have found a limited audience. The total volume across all twelve produces was less than 10,000 shares today and unfortunately that is a typical trading day for the ETRACS suite.

Even if you elect not to trade any of the ETRACS volatility ETPs, studying their price movements can yield a fair amount of insight. All were first traded on September 8, when the VIX was trading at about 34. In the intervening period, all the long VIX products have lost ground (from -8% to -38%, depending upon target maturity), while all the inverse products have made money (from +5.9% to +15.8%, depending upon target maturity), as shown in the graphic below. Due largely to the ravages of term structure and negative roll yield, the losses have been larger than the gains and the mean performance across all twelve ETPs (solid bright red line) has been a loss of 5.6% during the five months and twenty days since these products were launched.

Should these ETRACS product turn out to have a long life (and they will likely need a lot more fans if this is going to be the case), then they will paint a fascinating picture of the evolving VIX term structure and the consequences of negative and positive roll yield. As it is now, even the short-lived mirror image lines tell a story that is worth paying attention to.

[source(s): Yahoo]

Disclosure(s): long BBVX; short TVIX and UVXY at time of writing

Monday, February 27, 2012

The Biggest VIX Spike Ever: A Retrospective

Here is a thought experiment: when was the biggest one day VIX spike ever recorded? If you said February 27, 2007 – five years ago today – then I imagine you are in the distinct minority, even among active traders of VIX products.

There were a number of factors which helped to trigger the mostly forgotten record VIX spike back in 2007 – and with it a 3.5% decline in the S&P 500 index. Most media reports at the time focused on a drop in Chinese stocks. In fact, as I noted later, concerns about the Chinese government raising interest rates to discourage speculation helped to trigger an 8.8% loss in the Shanghai Composite Index and a 9.9% loss in the FTSE/Xinhua China 25 index that is the basis for the popular Chinese ETF, FXI. Various other news reports pointed to concerning U.S. economic data and there were some who were apparently spooked by a Taliban suicide bombing attack in Afghanistan that targeted Vice President Dick Cheney.

Interestingly, concerns about a sub-prime crisis or a real estate bubble were almost nowhere to be found at the time.

Of course the world was a lot different back in 2007. I had just started blogging one month before the VIX spike and in a world where a sub-10 VIX was common, I added the tongue-in-cheek tagline to the blog: “Your One-Stop VIX-Centric View of the Universe…” Twitter was in its infancy, CNBC hadn’t even thought about the idea of running a VIX ticker across your TV screen and most people didn’t even know what the VIX was at that time.

For those who may be interested in a little financial archeology, I put up eight posts that day to chronicle the magnitude of the move and offer an interpretive wrapper for those who were looking for more information:

…and added some trading ideas in another post prior to the next day’s open:

Four Ways to Play VIX Options Following a Record 64% Move to 18.31

Note also that the blogging world was much smaller and more intimate in those days, so I was not surprised to see that David Merkel, Trading Goddess, Option Pundit, Jim Kingsland, Headline Charts, Lauriston Letter and other blogging luminaries of that era dropping by to add their thoughts in the comments section.

Of course this is where I typically get peppered with dozens of, “So what does a big one day spike in the VIX mean?” questions, so I have taken the liberty of highlighting the ten largest single day VIX spikes over the last 22 years (which includes reconstructed VIX calculations). As I see it, these one day spikes are typically instances in which a number of investors suddenly get their first glimpse of a dark gray swan and they panic, not knowing what is around the corner. For the most part, the panic turns out to be an overreaction. Of course, occasionally the big spike can look like a precursor of doom in retrospect, as was the case on September 29, 2008, when the VIX spiked 34.5%, just before stocks went into their plunge. When I see a big VIX spike, however, the first thing I do is get out my mean reversion trading kit.

[source(s): StockCharts.com]

Disclosure(s): long FXI at time of writing

Sunday, February 26, 2012

All About UVXY

With the media feeding frenzy surrounding the VelocityShares Daily 2x VIX Short-Term ETN (TVIX) during the past week, a similar product, the ProShares Ultra VIX Short-Term Futures ETF (UVXY), has been largely overlooked. This is unfortunate, as UVXY has a great deal to recommend it.

I talk of UVXY and TVIX as equivalent instead of equal, largely because UVXY is an ETF while TVIX is an ETN. The magnitude of this distinction is debatable, but suffice it to say that with UVXY an investor holds VIX front month and second month VIX futures that are used to mimic two times the moves in the S&P 500 VIX Short-Term Futures Index. With TVIX, the story is a little different, as this ETN is a debt security in which Credit Suisse (CS) essentially promises to pay investors two times the performance of the S&P 500 VIX Short-Term Futures Index. With the Credit Suisse TVIX product, therefore, there is some risk that these “senior, unsecured obligations” may not be repaid in some future scenarios.

There are other important distinctions between ETF and ETNs that I will not delve into here, but two important ones are the differences in tracking error (ETFs should not have any tracking error) and tax treatment, which is often a murky subject that is open to interpretation. I should know: I married a CPA/tax attorney and in spite of that fact, my knowledge about tax matters is only incrementally greater than when I was a single man…

The graphic below captures the performance of UVXY and TVIX since UVXY’s launch on October 4, 2011. Now it may just be a coincidence, but TVIX made a 52-week high of 109.17 on the very same day that UVXY was launched. As the graphic below shows, in the intervening 4 months and 3 weeks, both UVXY and TVIX have fallen in excess of 80%. For the most part, these two securities have tracked each other step for step across a variety of market conditions. That relationship was disrupted on Tuesday when Credit Suisse suspended creation units in TVIX. During the last three trading sessions, UVXY has continued to fall -11.6%, while the supply-demand imbalance has limited losses in TVIX to just 2.1%.

With TVIX trading essentially as a closed-end fund, its price will be much more difficult to predict going forward, which should make UVXY more attractive to investors. Clearly UVXY is already gaining fans in this new market environment, where it set new volume records on Thursday and Friday, with over 5 million shares changing hands on both days. Just two weeks ago UVXY’s volume was about 5% of what TVIX was trading. As of Friday, that number has jumped up to 38%.

With UVXY’s price now down in the 5s, I would expect to see a reverse split soon, perhaps even a 1-10 reverse split.

From the UVXY prospectus:

“If the Sponsor believes that the per Share price of a Fund in the secondary market has fallen outside a desirable trading price range, the Sponsor may direct the Trust to declare a split or reverse split in the number of Shares outstanding and, if necessary in the Sponsor’s opinion, to make a corresponding change in the number of Shares of a Fund constituting a Creation Unit.”

ProShares is no stranger to reverse splits for their ETFs. In April 2010, ProShares initiated reverse splits in nine ETFs, with the majority of those being 1-5 splits, but UYG and ZSL subjected to a 1-10 reverse split.

During the last week, the media have focused most of their attention on TVIX and the suspension of creation units. For traders and investors, however, their attention appears to be pivoting in the direction of UVXY. The rising popularity of UVXY could have some interesting consequences, not the least of which might be a more favorable environment for Credit Suisse to consider re-opening the creation unit window.

[source(s): StockCharts.com]

Disclosure(s): short TVIX and UVXY at time of writing

Friday, February 24, 2012

The Story of VIX ETPs Relative to their Intraday Indicative Values

This week has seen an explosion of interest in the VIX exchange-traded product (ETP) space, most of which has been due to the suspension by Credit Suisse (CS) of creation units (think ‘new shares’) in the VelocityShares Daily 2x VIX Short-Term ETNs (TVIX).

For those who are late to the story and/or would like some background, the links below should suffice, but for today I am interested in some data that might indicate how much stress there is in the market for TVIX shares, for VelocityShares products other than TVIX and for a ProShares product that is similar to TVIX, but is an ETF rather than an ETN: the ProShares Ultra VIX Short-Term Futures ETF, UVXY.

For this analysis, I have evaluated the prices of a handful of VIX ETPs relative to their Intraday Indicative Value (a real-time estimate of an ETP’s fair value, based on the most recent prices of its underlying securities) for the last week. The graphic below shows the premium for five VIX ETPs as a percentage of their indicative values, normalized to a 100 point scale.

The chart shows that prior to the suspension of new creation units in TVIX after the close of regular trading on Tuesday, February 21^st, these VIX ETPs generally traded very close to their indicative values. In fact, the norm for the long ETPs (TVIX, UVXY, VXX and VIIX) was to trade at a slight premium to the indicative value, generally less than 1% higher. By contrast, the one inverse ETP on the list, XIV, tended to trade at a slight discount to indicative value, again, generally less than 1%.

Once Credit Suisse closed the door for new creation units, the price of TVIX has drifted steadily higher relative to its indicative value, even trading at a 20% premium just a few minutes ago.

In terms of other market dislocations, however, the evidence is not compelling. UVXY, which is an excellent substitute for TVIX, doubled its prior record volume yesterday and is on schedule to top that today, but after seeing a slight lift in the premium relative to indicative value, UVXY’s premium is now back to historical norms.

Looking at some of the other VelocityShares products, the two next most popular after TVIX are XIV and VIIX. Here again, there have been some minor fluctuations since the Credit Suisse announcement, but nothing that has pushed these products more than 1% away from their indicative value.

Based on the indicative value data, then, so far the only market dislocation has been in the TVIX product, with no evidence of a spread to competing products (UVXY) or other products in the VelocityShares stable, such as XIV or VIIX.

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

Disclosure(s): long XIV; short TVIX, UVXY and VXX at time of writing

Thursday, February 23, 2012

TVIX Premium Spikes to 13%

A little more than two hours into today’s regular trading session, the premium in TVIX is has spiked to 13.5% above its intraday indicative value.

The graphic below shows the difference between TVIX and TVIX.IV over the course of the past three trading sessions, using 5-minute bars and reflecting the extended hours trading sessions in the grayed-out blocks.

At this juncture, longs are likely betting that the prospect of a short squeeze, perhaps in combination with a VIX spike, could land them some significant windfall profits. Shorts, on the other hand, are assuming that it is just a matter of time before Credit Suisse (CS) reopens the creation units window for TVIX, which should restore the supply-demand equilibrium and dissolve the 13% premium in the form of a different type of windfall profit.

[It is generally my policy not to comment on individual holdings other than to note them in the disclosure section below, but suffice it to say that as the TVIX premium increases, I find it increasingly difficult to make the bull case in terms of anticipating an additional expansion of that premium.]

[source(s): thinkorswim/TD Ameritrade]

Disclosure(s): short TVIX at time of writing

Wednesday, February 22, 2012

The Ups and Downs of the New Premium in TVIX

After 2 ½ hours of trading in today’s regular session, it looks as if the market is starting to get a handle on what sort of premium is appropriate for the VelocityShares Daily 2x VIX Short-Term ETNs (TVIX).

Yesterday I noted that Credit Suisse (CS) suspended creation units in TVIX due to “internal limits on the size of the ETNs.” Today it is possible to track the impact of that decision on shares of TVIX relative to its intraday indicative value and/or relative to a similar ETF, UVXY.

The graphic below, which is created in thinkorswim/TD Ameritrade using a “ticker” of TVIX-TVIX.IV shows the difference between TVIX relative to its indicative value. Note that this difference was as high as 1.04 points (6.0%) earlier in today’s session and has fallen as low as 2.3% in the last few minutes.

For those who are unable to generate TVIX.IV quotes with their data provider, just look at today’s percentage change in TVIX minus the change in UVXY to get a sense of the new TVIX premium.

Clearly the markets believe some sort of premium is appropriate, perhaps in anticipation of a possible short squeeze in TVIX.

Anyone who had a position in TVIX coming into today’s session has clearly been impacted by the imbalance between supply and demand. Going forward, the appropriate question for new longs or shorts is whether the current TVIX premium level will increase, decrease or remain the same. Before anyone jumps to conclusions based on a couple of hours of trading, it would be helpful to see what happens to the TVIX-TVIX.IV relationship during the next big VIX spike. I would certainly not assume that the current premium is appropriate for all market conditions.

For another perspective on TVIX (as well as some top notch research on GAZ and some other ETP anomalies), check out Kid Dynamite’s excellent TVIX – Not Your Daddy’s Blue Chip.

[source(s): thinkorswim/TD Ameritrade]

Disclosure(s): short TVIX at time of writing

Tuesday, February 21, 2012

Credit Suisse Suspends Creation Units in TVIX: What It Means

After today’s regular trading session, Credit Suisse (CS) announced in a brief press release that it has “temporarily suspended further issuances of the VelocityShares Daily 2x VIX Short-Term ETNs (TVIX) due to internal limits on the size of the ETNs.” The company added that “[t]his suspension does not affect the Early Redemption rights of noteholders as described in the pricing supplement. Other ETNs issued by Credit Suisse are not affected by this suspension.”

The announcement by Credit Suisse raises a lot of questions and I will see what I can do to answer some of the more pressing ones this evening.

While this is all speculation, based on the “internal limits on the size of the ETNs,” it sounds as if the recent exponential growth in TVIX has violated a position size risk control rule relative to the VIX futures products that comprise the S&P 500 VIX Short-Term Futures Index ER [excess return] on which TVIX is based. Of course we do not know how much the volatility of those VIX futures products is factored into the position size issue, but given the overhang of events in Europe, China and Iran, I can certainly make the case for a very conservative approach to risk control for any VIX futures exposure at the moment.

The suspension of creation units means that the 40,725,000 shares outstanding represents the upper limit for Credit Suisse. While Credit Suisse describes the action as temporary, there is no particular reason to believe the suspension will be a matter of days. It could possibly be weeks or longer before Credit Suisse agrees to issue new TVIX creation units. Back in 2009, for instance, the United States Natural Gas Fund (UNG) experienced regulatory approval issues for creation units and suspended new creation units for seven weeks. At one point in time, UNG traded as high as 16% over net asset value, but that premium turned out to be a temporary spike. Suspension of creation units, while unusual, does happen on occasion. Less than two weeks ago, to pick a recent example, Deutsche Bank (DB) halted creation units on seven of its commodity ETNs.

The big question for investors is whether the suspension of creation units will mean that TVIX trades at a premium or discount to its net asset value. Given that supply is constrained and demand is not, the most likely scenario is that TVIX will trade at least as high as net asset value or possibly at a premium. Valuation will be highly dependent upon arbitrage opportunities and there are quite a few arbitrage opportunities should TVIX begin to separate from its NAV. VIX futures provide an attractive source of arbitrage firepower, as does the very similar 2x VIX futures ETF, UVXY, formally known as the ProShares Ultra VIX Short-Term Futures ETF. Arbitrage opportunities are also available via VXX, VIX options as well as options on SPX/SPY, etc.

In terms of the reaction in the markets, we have some after-hours market data to give us an initial sense of the response to the TVIX announcement. TVIX closed the regular session at 17.01 and was last traded at 17.02 when the news crossed the wire and volume spiked. TVIX initially rose a little more than 1% to 17.26, gave back most of those gains, then rose again as high as 17.31 before finishing the after-hours session at 17.28, up 0.27 or 1.6% from the close.

Traders should be aware that each ETP has an Intraday Indicative Value (IV or sometimes IIV), which is essentially a real-time estimate of an ETP’s fair value, based on the most recent prices of its underlying securities. These quotes are updated every 15 seconds and can help determine the extent to which a security has deviated from this measure of fair value. In the graphic below, I have captured the difference between TVIX and TVIX.IV during the last hour of the regular trading session and throughout the (grayed out) after-hours trading session, where TVIX rose to 0.29 above its intraday indicative value.

During tomorrow’s session, keep an eye on TVIX relative to TVIX.IV and also the ratio of TVIX to UVXY. At yesterday’s close, TVIX was trading at a multiple of 2.625 times that of UVXY.

In the short-term, I would expect a small premium to creep in to the price of TVIX, but arbitrage to keep that premium in check. Over the longer term, the price of TVIX will continue to respond to the Four Key Drivers of the Price of TVIX I outlined yesterday, in addition to any market dislocations caused by the suspension of creation units for TVIX.

Should the VIX futures market continue its recent growth trajectory and Credit Suisse ratchet down their relative exposure to that growing market, I would expect to see the resumption of creation units in TVIX in the relatively near future. The timing of this development is difficult to project, as there are quite a few things that can happen in the world of volatility between now and then.

[source(s): thinkorswim/TD Ameritrade]

Disclosure(s): short TVIX, VXX and UNG at time of writing

An Updated Field Guide to VIX ETPs

With the sudden success of TVIX, it seems as if the entire VIX exchange-traded product (ETP) space has a large number of new converts. Growing from just two products at the end of 2009 (VXX and VXZ) to 12 by the end of 2010 and 31 by the end of 2011, VIX ETPs are a growth industry.

For those who trade or invest in the VIX ETP space, I thought the graphic below – a field guide of sorts – might be of assistance. The intent of the graphic is to differentiate between the various VIX and volatility-based ETPs primarily by mapping them according to target duration and leverage. The key at the bottom of the graphic highlights some additional distinctions, such as:

ETPs that hold some non-VIX securities in their portfolio are marked by a black triangle. These include VQT and CVOL, which hold long or short positions in SPX/SPY
ETPs that include both long and short VIX positions in their portfolio (VQT, XVZ and XVIX) are flagged with a red/green rectangle
ETPs with a dotted outline (VQT and XVZ) have a rule-based dynamic allocation of volatility components
the red ovals highlight those five VIX ETPs that are currently optionable
the large light red shaded area incorporates all the ETPs that use 2x leverage (there are no 3x VIX ETPs)
the large orange shaded area incorporates all the ETPs which have a target average weighted one month duration and thus are particularly susceptible to the influence of contango and negative roll yield in the VIX futures portion of their holdings

There are some other important distinctions that are difficult to work into the chart, but one I did incorporate was to flag VIX ETFs (from ProShares) in a black font, while all the ETNs are in a blue font.

For the sake of completeness, I also included a necrology of the two VIX ETPs that were closed last year. Interestingly, both were immediately succeeded with virtually identical products that trade under a similar ticker.

Going forward I fear that the next round of VIX ETPs may make it impossible to capture the same level of detail as I have done in this single page, but for now at least, this is my reference of choice for VIX ETPs.

Disclosure(s): long XVZ, short VXX and short TVIX at time of writing

DISCLAIMER: "VIX®" is a trademark of Chicago Board Options Exchange, Incorporated. Chicago Board Options Exchange, Incorporated is not affiliated with this website or this website's owner's or operators. CBOE assumes no responsibility for the accuracy or completeness or any other aspect of any content posted on this website by its operator or any third party. All content on this site is provided for informational and entertainment purposes only and is not intended as advice to buy or sell any securities. Stocks are difficult to trade; options are even harder. When it comes to VIX derivatives, don't fall into the trap of thinking that just because you can ride a horse, you can ride an alligator. Please do your own homework and accept full responsibility for any investment decisions you make. No content on this site can be used for commercial purposes without the prior written permission of the author. Copyright © 2007-2023 Bill Luby. All rights reserved.

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