I've been enjoying a wonderful week down in Jamaica, but I knew based on my full inbox, that many of you were still wondering what was going on with the TVIX, the Velocity Shares Daily 2X VIX Short-Term ETN . So here is the short and sweet explanation of what's behind such outrageous moves in this ETN:
Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) are fairly vanilla products, they do what they're supposed to do, track performance of an index, future etc.
This all changes with levered ETFs and ETNs. Instead of just owning the S&P 500 in a SPDR Trust, the ProShares SSO for instance, provides twice the daily movement of that index. The added boost comes from an OTC Swap done with trading desks like GS, CS and DB.
These levered ETFs & ETNs reset every single day, so if you hold them over a 30 percent move that takes 3 to 6 months, the levered ETF or ETN will NOT track twice that 30 percent move.
The investor may feel this is not "fair" and that someone has gamed the system, but this is not the case. It's that daily reset that makes these levered products not suitable for long-term investing. They are great for short-term hedging, or for adding alpha to your day trading, but not for long-term holding!
Another issue that plagues some of these is the process of creation of the ETF or ETN. Someone actually does this, and if there is more demand for the ETF or ETN than there have been creations, or if some firm owns a bunch and will not lend them out, then there is a hard to borrow placed on the ETF or ETN and this disrupts pricing and trading significantly.
As it turns out both the creation issue and the daily reset are to blame for the TVIX and the crazy pricing and trading of that ETN over the past month. Credit Suisse ceased creation of the notes on February 21st after the ETN had seen inflows that swelled it from $162 million in late 2011 to over $700 million in early 2012. This surging demand and the pause in creation of the notes caused them to hold a value (premium) significantly higher than was warranted until the past two sessions when the ETN fell to earth.
The TVIX has fallen from just over $15 into the bell on Wednesday to $7.98 moments ago, an astonishing drop of 46 percent!
While it must be true that there have been significant losses suffered by buyers of this ETN (rumors running into the $100 million range) looking to either profit from a rising VIX, or as a hedge against an S&P downturn, the fact remains that levered instruments like TVIX should only be used by those that understand both the pricing (creation) and the impact of daily resets.
