VelocityShares Daily 2X VIX Short-term ETN (TVIX), an increasingly popular volatility product, is an exchange traded note (ETN) provided by Credit Suisse that seeks to provide two times the daily return of the S&P Short Term VIX Futures Index (SPVXSTR), the same index tracked by the popular iPath S&P 500 VIX Short-Term Futures ETN (VXX). SPVXSTR maintains positions in first and second month VIX futures in a ratio weighted to provide constant exposure at a one-month horizon.
TVIX has been in the news recently.* On February 21, CS announced that it was suspending issuance of new TVIX shares “due to internal limits on the size of ETNs.” The emerging consensus is that, in all likelihood, the firm did not want to issue more shares than it could hedge at an economically attractive rate. Because TVIX is an exchange traded note rather than an exchange traded fund, its issuer is free to hedge its exposure in whatever way it wishes. For most ETNs, this is not a problem, but the daily rebalancing requirements and payoff convexity in leveraged products like TVIX poses serious risks to CS, since it alone would bear the costs of any tracking error between the index and firm positions. Imposing internal limits is a responsible way of ensuring that exposure does not become unmanageable.
TVIX: Daily Prices; Source: TD Ameritrade
One issue that worried some investors was whether the explosion of trading volume in January and February (see the gray volume background in the chart above) might change the dynamics in CBOE Volatility Index (VIX) futures, since presumably CS would want to hedge at least some of its exposure in those products. A report from Barclays analysts this week concluded that, based on the relationship between VIX futures values and forward SPX variance swaps, any effects from higher TVIX volume would have been felt in SPX implied volatility as well and not in VIX futures alone.
Discount of VIX futures relative to corresponding forward variance swaps; Source: Barclays Capital, Bloomberg
However, the roll yield for SPVXSTR is higher than at any time since January 2007, as VIX futures are priced well above the spot or cash VIX level. That means products like VXX and TVIX will continue to see a drag on returns as they are forced to sell cheaper front month contracts to buy more expensive second month contracts. It is hard to say how much of this increased negative roll yield is attributable to TVIX, but traders can certainly take advantage of the situation.
- Investors could take an equally weighted short position in VXX and long position in iPath S&P 500 VIX Short-Term Futures ETN (VXZ). VXZ does not suffer from negative roll yield nearly as much as the former product, but will hedge exposure if volatility increases.
- Traders could sell at the money VIX straddles and hedge the position deltas with VIX or Mini-VIX futures. This has been a favorite of the Barclays team for some time and it will be interesting to see whether the high VIX options risk premium persists if 2012 remains as quiet as it has been so far.
* Every financial news outlet worth its salt has covered the TVIX story, but my friend Bill Luby was one of the first sources to cover this story in sufficient detail, and you can read the linked archive for more discussion of TVIX. (VIX and More)