The halt in TVIX share issuance and the fact that, on some days, VIX-based ETF/ETN rebalancing accounts for 90% of VIX futures volume has caused some pretty wild speculation. I’ve been too busy this week to write a proper rebuttal, but here are some points that will help you steer clear of all the needless hand-wringing:
- The rolling of contracts in VXX and similar products is in no way “entirely game-able,” for the same reason that the term structure of implied volatility in SPX options is not gameable. If the values of VXX shares, VIX futures, or SPX implied volatility is high, that’s because of customer order flow, not because ETN issuers have somehow broken or even altered the market. VXX has a negative roll yield, as is well understood, and if you pursue constant long volatility exposure with a short time horizon in any equity index options product, you’ll pay a similar cost. Volatility arbitrage stragies, where they exist, exist because of structural features of markets and the psychology of market participants, not because some ETN became popular.
- The supply of crude oil is poignantly finite, and someone with a big enough futures position might be able to affect the market. The supply of long SPX volatility exposure is, for our purposes, practically infinite. So proposing position limits in VIX futures doesn’t make any sense. We might as well limit the number of shares of SPY people can buy.
- The fact that customer order flow is on the long side of volatility and that ETN issuers are constantly hedging short vol exposure is a good thing. Well-hedged retail investors are better than panicking, unhedged retail investors, and dealers can take care of themselves well enough, as Credit Suisse demonstrated in February with TVIX.
- For some reason, the folksy, y’all-be-careful-now tone of this article really irks me. The VIX is not such a “curious beast” once you’ve spent a little time with it. Can we please treat investors like the adults that they are? Seriously: ”The answer, it turns out, is that any rational investor would look at the VIX futures market and run away screaming.” No, rational investors do not scream and flee from the existence of liquid, actively traded volatility derivatives.
When information about products most investors don’t understand anyway gets mixed in with a lot of exclamation points and arch rhetoric, it does nobody any favors. Cf. the public perception of OTC swaps and derivatives.
Vance Harwood has written up a very careful and thorough review of this question about the market impact of volatility ETPs, and you should click through to his piece for more details. I couldn’t agree more with his conclusion:
I understand that shifting $50 million or more a day to rebalance an ETN with a billion dollars in assets is not a trifling thing, but compared to the $10 trillion market cap of the S&P 500 this feels like a tempest in a teapot.