Friday, March 23, 2012

TVIX - Pass the Dramamine Please

The $VIX tracking ETF's and ETN's, UVXY and TVIX had a wild week.

And, just to make things interesting Credit Suisse made the following announcement yesterday which let the air out of the tires. From the PDF (link below)

"Credit Suisse Plans to Reopen Issuance of VelocityShares Daily 2x Long VIX Short-Term ETN (Ticker Symbol: “TVIX”) on a Limited Basis

New York, March 22, 2012 Credit Suisse announced today that it plans to reopen issuance of the VelocityShares Daily 2x VIX Short-Term ETNs (Ticker Symbol: “TVIX”) on a limited basis. The ETNs were temporarily suspended from further issuance by Credit Suisse on February 21, 2012 due to internal limits on the size of the ETNs. At present, the ETNs are trading at a premium to their indicative value. "

I've stopped trading TVIX because I don't know how to value it. I made money on it the first go-around but have since stayed away from both TVIX and UVXY. The UVXY traded closer to what I expected 2X the daily change on the $VIX but this week neither seemed to be following the $VIX. Since, especially in the case of TVIX which now trades like a close end fund, they can trade at a premium and when the premium unwinds like it did this week, the hedge gets sheered. (Read the prospectus for these instruments)

I tracked the UVXY/TVIX ratio and in the past it ranged between 2.22 and 2.39, with its centerline about 2.29. It finished the day at 2.19 indicating the TVIX is abour 6% over the middle value.

The TVIX closed at $7.16 and the UVXY at $15.66 so either the TVIX is $0.35 overvalued or the UVXY is $0.80 undervalued.

The problem for me is that there are too many variables to track and utilize when making a quick decision as a portfolio hedge. It worked once but I was lucky.

As noted, I had done research on TVIX earlier and decided to stay away from it. The main reason was that Credit Suisse halted share creation because of their capital risk requirements. This essentially turns TVIX into a closed end fund since there won't be any more shares issued in the near term. This means that investors will do what they did and bid the price up on TVIX if they think the market is going to decline (make the $VIX go up)

However, here's the gotcha. The prospectus suggests that the TVIX will approximate the 2X daily percentage change in the VIX futures contract (plus all that other interest rate stuff)

So hypothetically, if TVIX starts at $10 and the VIX is up 5%, TVIX should go up 10% to $11.

Suppose investors are frightened and bid TVIX up to $11.50. This is usually not a problem because the excess should be priced out the next day. If there was no change in the VIX then TVIX should remain at $11.50 (also no change from the previous day's inflated price) but it is more likely it gets sold down during the day to its fair value or $11.

BUT, now suppose, fear makes the VIX rise each day for 3 days, what happens?
Assuming exact VIX correlation and the following VIX changes:
Day 1 = +5%, Day 2 = +20%, day 3 = +5%

Then the expected TVIX changes would be 2X the VIX changes:
Day 1 = +10%, Day 2 = +40%, day 3 = +10%

Fair Value = 10*1.1*1.4*1.1 = 16.94 (expected value)

5% Premium = 10*1.15*1.45*1.15 = 19.18 (value + the premium)

Total premium after 3 days = 19.18/16.94 = 1.13 or a 13% Premium

While my numbers are dramatic, smaller incremental premiums crept into the TVIX price over a longer period. I suspect some hedge fund figured out how to recreate the underlying TVIX using the futures and by shorting TVIX and being long the underlying instruments they capture the difference with minimal risk. And the TVIX collapsed.

In general I prefer the UVXY which has the same leverage and less of a tendency to accumulate premium. But when trading the TVIX, one must watch the UVXY/TVIX ratio closely and if it gets out of the range I indicated, bail out or switch instruments.

Here is what the ratio chart looks like:
The UVXY/TVIX ratio
Click to enlarge

Here is the price action for the week ending March 23.
Price action on he UVXY TVIX and $VIX
Click to enlarge

Adding charts here for the ^TVIX-IV which essentially is the fair value of the TVIX. If one is trading the TVIX, it would pay to keep ones eye on both the TVIX and its relationship to the ^TVIX-IV, as well as the ^VIX and what the genera; market is doing.; ;-)

Price action on he TVIX-IV TVIX and $VIX
Click to enlarge

And from Bloomberg, here is a month long chart of the TVIXIV vs the TVIX: The distance between the green line (TVIX) and the orange line TVIXIV) is the premium:. For most of the life of this instrument, the TVIX and TVIXIV have remained close to one another which is what one would expect. The recent divergence and expanding premium of the TVIX over the underlying TVIXIV was in part caused by Credit Suisse suspending the issuance of new TVIX shares as demand increased.

Price action on he TVIX-IV TVIX and $VIX
Click to enlarge

Price action on he TVIX-IV TVIX, $VIX and UVXY
Note that the UVXY closely tracks the TVIXIX
This chart should update so it is the most recent 5 days
Click to enlarge


Anonymous said...

Hey George! How you doing? Glad to see you're posting a little more frequent. I always like to hear other takes on the market. A while back, TVIX came to my attention. I tried to understand it's inner-workings, but the whole idea wasn't clear. When I got to this line in the prospectus, I dropped the idea. "The long term expected value of your ETNs is zero. If you hold your ETNs as a long term investment, it is likely that you will lose all or a substantial portion of your investment."
I'm still working a little more than full time, so I can't follow the market as much as I need to. The result is that I'm mainly in preferreds, a couple BDC's and a few CEF's. They are paying well, and I'm doing OK with the level of attention I am able to give to them.
Keep posting when you get a chance - I always enjoy it!

Russ - from LutzCats

George said...

Hi Russ, You have to be careful with all the leverages ETF's and ETN's. In reading about ETN's I decided to avoid them because of their complexity. So for a leveraged Volatility instrument, my choice is UVXY but only for very short term hedging trades.

I did ok with TVIX but I was really lucky, I held it just to see what it would do and when it started moving only at 1 for 1 with the VIX I did a lot of DD to see why. It's encapsulated here.

In general the short side ETF's tend to lose value over time, they make lower lows when the underlying makes the same low. The Credit Suisse prospectus outlines the risks in TVIX and indicates it is really best used as a trading instrument.

FWIW, check out my next post on the banking stocks. I'm trying to deploy funds into this sector because it has an upside of 50% to 100% for quality companies

I'm around more now to answer questions.