Saturday, March 24, 2012

With a 50% drop TVIX snaps back to NAV

Shorting equity volatility has been an amazing trade in recent months. For example here is a chart of VXX, the VIX futures ETF, collapsing below the pre-2011-crisis levels. ETFs like VXX roll the nearby futures contracts, and as the VIX futures curve steepened, the cost of this roll (the "negative carry") rose. The increased cost of the roll was on top of the general collapse in the VIX index, sharply lowering the value of the ETF. A great deal of money has been made on this short.

VXX share price (Bloomberg)

But as discussed a few days back, why settle for the 1x VIX futures when you can short 2x via TVIX. Except TVIX is not an ETF - it's an exchange traded note (ETN). The manager does not have to issue new shares if the security trades at a premium to NAV (see this post for the ETF mechanics). With the number of participants taking short positions rising, a short squeeze ensued last week.

TVIX short interest

The press and apparently the SEC (though this has not been verified) gave the manager a wake-up call.
WSJ: Credit Suisse AG (CS) on Friday reopened issuance of a leveraged exchange-traded note tied to the market's fear gauge, a month after the bank suspended new issues following a rush of demand.

The reissuance of shares follows a month of unusual market performance in the VelocityShares Daily 2x VIX Short-Term ETNs (TVIX), capped by a two-session decline during which time the ETN hemorrhaged half its market value.

Friday, TVIX fell 30% to close at an all-time low of $7.16.

Credit Suisse said in a news release late Thursday it will resume issuance Friday on "on a limited basis," after the bank suspended new issues on Feb. 21, citing "internal limits on the size of the ETNs."

TVIX shares outstanding

Under pressure, CS issued more shares, which hit the market all at once, collapsing the premium to NAV - price dropping by some 50% in a couple of days.

TVIX price vs. NAV

It is likely the SEC will have a few things to say about this. Arbitrarily changing or holding constant the number of shares outstanding, no matter what the reason is, causes tremendous market distortions. Products like these may be deemed inappropriate for retail investors, particularly when the manager can effectively manipulate the price.
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