Some news on the Volatility ETN front the other day as Credit Suisse announced they are suspending furthur issuances in their TVIX product, a double long VIX short-term futures. From the press release:
NEW YORK, Feb. 21, 2012 /PRNewswire via COMTEX/ — Credit Suisse announced today that it has temporarily suspended further issuances of the VelocityShares Daily 2x VIX Short-Term ETNs (ticker symbol:”TVIX”) due to internal limits on the size of the ETNs. This 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.
As Rapoport notes, this time it’s ‘internal limits’ which are being cited:
Last night, Credit Suisse announced that it is suspending new share issuance in TVIX, citing internal limits on the size of the ETN. This effectively makes TVIX a closed end fund. So if demand for the product continues, TVIX could start trading at a premium to NAV. We’ve seen situations like this before in other products. Back in Nov’09, for example, UUP had to suspend share issuance as it bumped up against the max allotment allowed by regulators. The fund administrator applied for an increase in share count, but while the market waited on approval, UUP traded at a 46c premium to NAV.
Though this is the odd thing. As yet — at least to our knowledge — there are no regulatory limits that apply to Vix futures. (Although as we noted in our previous post, we’re not sure why. You’d think the same arguments about passive funds skewing the underlying due to their massive positions would apply just as much to volatility as they do to commodities. But perhaps no-one in the political sphere has really thought about that impact yet?)
Besides it’s quite clear that Vix futures are not really the issue here. This is all down to Credit Suisse’ own internal limits. Which highlights yet another point we’ve made already. Since this is an Exchnage Traded NOTE, rather than a fund, Credit Suisse can hedge its exposure any way it wishes. It doesn’t have to own any Vix futures at all. It can for example recycle its own internal volatility position to hedge the product instead.
Which makes us wonder, is the sudden popularity of TVIX more to do with pushing Credit Suisse beyond its limits — i.e. to a point where it is forced to plunge into the underlying market at great expense or suspend issuance outright — than a genuine desire to hold the underlying instrument?
Rapoport’s thinking is possibly yes:
Is it possible that the buyer of TVIX shares has been buying with Credit Suisse’s limit in mind? We haven’t had a great explanation of where the TVIX demand was coming from. It’s not impossible that a large buyer was accumulating with the intent to corner…
My, that would be
Bill Luby, who does a great job tracking these products at his VIXandMore blog focuses in on the possibilities of strange price action in TVIX given the action by CS:
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.
What I’m interested in is the effect these products and the trading of them could have on the VIX in general and volatility in the market. Alot has been written and said with concerns about these leveraged ETFs/ETNs and their effect on the market. Many people thought that the introduction of the SPX and QQQ leveraged ETFs added to market volatility, especially in the closing minutes of trading in the wild and whacky days we’ve seen since ’08.’Henry Chien of the Tabb Group looked into this in regards to the VIX last month, as reported by FT:
As Chien notes, the big question really is whether the growth of VIX ETPs has affected the Vix market in a similar way to the single stock market. He notes there is increasing evidence that single stock volatility, for example, is being driven by index volatility.
Intuitively, however, the greatest imprint should come from the buying and selling in the rolling of the Vix futures contracts for short-term Vix products — something which should exert downwards pricing pressure on the front month Vix futures contract and upwards on the second month contract.
From the report:
Given that assets of short-term VIX ETPs have reached nearly a $1 billion, the effect is to steepen the contango in the front two months. This makes sense intuitively – if everyone is long implied volatility via the front month VIX futures, the ‘premium’ paid in contango should rise to reflect the popularity of the trade. This daily rolling of short-term VIX ETPs is estimated to account for up to 10% of VIX futures notional turnover. Negative roll yield for short term VIX ETPs due to contango can reach double digit basis points per day. This however, also translates into arbitrage opportunities.
But while the Vix curve has indeed had a tendency to sit in the contango formation, Chien believes this is nothing more than a function of the premium that must be paid to maintain implied volatility exposure.
Indeed, when the VIX jumps, notes Chien, the futures curve becomes backwardated with the VIX futures farther from expiration lower in price, resulting in ‘positive roll yield.’
Simply put, the greater the demand for passive exposure (via ETPs) the greater the premium charged via the contango. And that, suggests Chien, is fairly logical and to be expected. When backwardation strikes, passive volatility exposure is finally rewarded. (Although, if that’s a fair justification for why the Vix curve is always in contango, perhaps someone should tell commodity traders who seem more reluctant to embrace the same concept.)
But Chien notes an important difference between standard commodity futures and Vix futures. Since the Vix is not directly investable, there is no direct cash-futures arbitrage pricing between the VIX spot and Vix futures. In other words commodity traders can arbitrage their futures markets versus the physical much more easily than Vix traders can.
Nevertheless it is worth pointing out that in 2011 the average daily gross Vega volume of Vix derivatives was greater than that of the SPX options market. While market makers told Chien that this had not had an observable impact on the options themselves, Chien did point out that arbitrageurs do routinely buy and sell the Vix future versus strips of SPX options.
In his opinion, however, there is more than enough liquidity in the options market to ensure Vix values are not manipulated (for now).
As Chien concludes:
While the prices of VIX futures and options could potentially have feedback effects on the SPX options market, the evidence is not there or easily observed.
Of course, one factor not considered by the report is the extent to which Vix ETP providers internalise volatility hedges. Or rather, to what extent providers use their own natural volatility positions to hedge the products they provide to customers?
This we would really like to know.
These VIX products are intended for short term trading in the VIX futures, but what has been discovered by many people is that they are as much a product for trading VIX futures movements as they are for simply trading the contango/backwardation of those futures. With plenty of arbitrage possibilities contained therein.
We get a number of questions on these products and wanted to explain just how crazy they are. We’ll keep an eye on what’s going on and update with any news.