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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The TVIX short squeeze - welcome to the "safety" of exchange traded derivatives

Retail investors are pressing for stricter derivatives regulation in the financial services industry. Yet many of the same investors engage in derivatives trades that would make even an institutional structured products specialist uncomfortable.

Here is a good example - a product known by its ticker symbol as TVIX. It's issued by VelocityShares and is actually an exchange traded note traded on NYSE Arca. TVIX targets to replicate 2x the VIX futures performance (it's a leveraged note on futures contracts on options implied volatility - a "double" derivative). Here is the description:

VelocityShares Daily 2x VIX Short Term ETN is an exchange-traded note issued in the USA. The Note will provide investors with a cash payment at the scheduled maturity or early redemption based on 2X the performance of the underlying index, the SP 500 VIX Short-Term Futures Index less the Investor Fee.

As VIX came crashing down this year, people thought it may be a good idea to be short vol. It wasn't enough just being short though - they wanted to be 2x long US equity implied vol via TVIX. As more people kept piling in, it became what's known as a "crowded trade". Some people were short the ETN and long the VIX futures against it, trying to arb out the discrepancies between TVIX price and NAV. But before the weekend, someone decided to cover their short. And that's when the ETN began to rally, while VIX futures went lower. This continued into today.

In the last 5 days the VIX futures are down about 3%. According to the description above, TVIX should be down 2x or 6%. Yet TVIX is up over 7%.

TVIX vs VIX futures (Bloomberg)

The short squeeze has pushed the price up so much that TVIX now trades at over 36% above its net asset value.

TVIX premium to NAV

It is now nearly impossible to short TVIX since there are none to borrow - thus limited ability to arbitrage out the dislocation. By lunch time today TVIX is up over 1% for the day, while VIX futures are down 5%. So the next time you feel like shorting some vol, try using futures directly, or stick with SPY options. This is not for the faint-hearted and the fact that it is exchange traded (vs. OTC) doesn't make it a whole lot "safer".

SoberLook.com