Mon, Jan 26, 2009 | Jared Woodard
We’ve been trying to come up with a scenario in which we’d want to trade the new iPath S&P 500 VIX Futures ETNs being issued soon by Barclays, and we can’t think of one. There’s already been some helpful coverage of these products by the options blogs, and the links below deserve a visit for the full discussion, but we thought we’d summarize our thoughts on this:
- If you’re anyone at all looking for a robust portfolio hedge against a market crash, VIX futures and these VIX futures ETNs are not appropriate. The spectacular moves in the spot VIX that occurred during the crash of 2008 were not met with corresponding movement in the VIX futures, which is entirely to be expected, since the VIX futures will always price in more mean reversion than the spot. For a portfolio hedge, you’re better off in SPX puts.
- If you’re an institutional trader looking for a play on future expectations of future volatility, you likely already have access to the CFE and the VIX futures. So these ETNs are probably redundant and probably comparatively inferior given the credit risk and additional fees associated with them.
- You can’t trade the spot VIX. That’s well known to most options traders, but our concern is that traders who aren’t active in the options space will latch onto these ETNs thinking they’re getting a convenient spot VIX tracker. The Barclays filing is actually quite thorough on this point: the Pricing Supplement includes headings like “The VIX Index Is a Theoretical Calculation and Is Not a Tradable Index,” “Your ETN Is Not Linked to the VIX Index and the Value of Your ETN May Be Less Than It Would Have Been Had Your ETN Been Linked to the VIX Index,” and “The VIX Index Is A Measure of Forward Volatility of the S&P 500® Index and Your ETN Is Not Linked to the Options Used to Calculate the VIX Index, to the Actual Volatility of the S&P 500® Index or the Equity Securities Included in the S&P 500® Index, Nor Will the Return on Your ETN Be a Participation in the Actual Volatility of the S&P 500® Index.”
Despite those disclosures, we fully expect traders not to read the fine print, and for the reception of these VIX ETNs to follow roughly the same path that the inverse and double ETF products followed in 2007-8. It took quite a while for traders to realize that the 2x and 2x inverse (and related) products that track daily returns are not suitable for longer holding periods, and no doubt some of those realizations were spurred by illusory portfolio hedges that didn’t work as expected. (For example, see Adam’s take on how holding SKF would not have protected a long financials portfolio.) The same story will probably play out here: assuming we get some volume in these new ETNs, watch what happens the next time the VIX spikes in a big way – there will be accusations of foul play and tracking error.
The weirdness of the picture above (Conan, E.T., and Vigo the Carpathian) about captures our sense of unease about the complex products being offered to individual traders these days.