The old saying goes, “Traders love volatility.” You see, without volatility, the markets would be really boring… and traders would have a tough time making money. Now, there are volatility exchange-traded notes (ETNs) that provide investors with exposure to the CBOE Volatility Index (VIX). These could be great for when traders are anticipating a crashing market. However, these could be a gift and a curse if you don’t understand products like SVXY, UVXY, and TVIX. That said, let’s take a look at some leveraged and inverse volatility ETNs.
Volatility ETNs and Trading Explained
Now, there are a few ways to bet on volatility. If you don’t already know, when traders talk about volatility, it typically means they’re expecting a large down move. That said, when traders are expecting an increase in volatility, they could either outright short exchange-traded funds (ETFs) tracking the market… or they could buy put options and pull out winners like this:
Additionally, they could look to traditional ETNs like the iPath Series B S&P VIX Short-Term Futures ETN (VXXB). Keep in mind, VXX ceases to trade because its issuer redeemed the ETN. Again, you could use options to generate profits like this in VXXB – which is nearly identical to its predecessor VXX:
Moreover, you could outright buy volatility ETNs to potentially profit off of volatile moves. However, there are a few intricacies to keep in mind:
- Volatility ETNs trade like stocks. They could be bought, sold, or sold short any time during pre-market, market, and post-market trading hours.
- These products typically only track the percentage performance of their respective underlying indices for a period of one day. Due to the compounding of daily returns, it doesn’t make sense to buy and hold these ETNs for extended periods of time.
- Volatility ETNs are senior, unsecured, unsubordinated debt securities and have a maturity date. Moreover, they are only backed by the credit of the issuer.
- Depending on which product, it could potentially lose a large portion of its value – forcing the issuer to redeem the ETN (causing it to cease trading).
- Leveraged and inverse volatility ETNs are best left for sophisticated investors and traders. However, once you learn how to trade volatility products, it could potentially be lucrative and you might be able to multiply your money.
That said, let’s look at TVIX first and its inner workings.
VelocityShares Daily 2X VIX Short-Term ETN (TVIX)
TVIX aims to provide two times the S&P VIX Short-Term Futures Index’s daily percentage returns. For example, if the S&P VIX Short-Term Futures Index (TVIX’s underlying index) rises by 5%, TVIX should theoretically rise by 10% that day. Now, the underlying index provides exposure to a daily rolling long position in front and back month VIX futures contracts. Moreover, the index maintains a constant weighted maturity of one month.
In other words, the index gives traders and investors of where the market is expecting volatility to be around the next 30 days.
Now, since TVIX is leveraged, it’s considered a risky product. For example, if you buy TVIX when volatility is near the highs, and it pulls back significantly… you could lose a large portion of your capital. That said, this is not a buy and hold investment, and should only be traded actively, or with options.
There’s the ProShares Ultra VIX Short-Term Futures ETF (UVXY), which is often thought of as the cousin of TVIX.
ProShares Ultra VIX Short-Term Futures ETF (UVXY)
Now, UVXY made changes to its daily objective after the fallout of XIV, which we’ll get into later. Prior to February 28, 2018, UVXY aimed to provide investment results corresponding to two times the daily performance of its underlying index. Currently, UVXY aims to provide 1.5 times the daily performance of the S&P 500 VIX Short-Term Futures Index.
UVXY is not as risky due to the fact that the issuer cut its leverage factor from 2 to 1.5. That said, if the underlying index falls by 10%, UVXY would fall by 15%, whereas TVIX would fall by 20%.
UVXY is designed for those who understand volatility products and want to profit from increases in the 30-day expected volatility of the S&P 500 Index. Keep in mind, UVXY and TVIX do not track the performance of the CBOE Volatility Index (VIX). That said, both UVXY’s and TVIX’s daily performances could vary from that of the VIX.
Again, since UVXY is a leveraged ETN, it should not be held outright for extended periods. Due to the compounding of daily returns, UVXY’s returns over periods greater than one day would significantly differ from the target return.
Finally, this brings us to an inverse ETN – SVXY.
ProShares Short VIX Short-Term Futures ETN (SVXY)
Similar to leveraged ETNs, inverse volatility ETNs are risky. For example, when volatility doubles overnight, an inverse ETN tracking the performance would essentially be worthless.
We saw this happen with the VelocityShares Daily Inverse VIX Short-Term ETN (XIV). Now, if you’re looking to trade XIV… don’t bother, it ceases to exist, and here’s why.
XIV’s underlying index spiked ~100% overnight.
Well, what some traders and investors didn’t know was the fact that if XIV fell by more than 80%… the issuer would redeem the ETN, which it did.
Consequently, this caused a black swan-like event in the volatility markets.
Why’s this important?
Well, SVXY is an inverse ETN that aims to provide -0.5 times the daily performance of the S&P 500 VIX Short-Term Futures Index. In other words, if the underlying index falls by 10%, SVXY would rise by 5%. However, volatility is unbounded to the upside… so if the S&P 500 VIX Short-Term Futures Index spikes by say 200%, SVXY would be worthless. In turn, the issuer would probably redeem shares, just as Barclays did with XIV. Prior to February 28, 2018, SVXY’s daily objective was to offer -1 times the daily underlying index’s performance. However, once XIV “blew up,” multiple issuers cut the multiple factors to minimize risk.
Final Thoughts on TVIX, UVXY, SVXY
Volatility ETNs are not for the faint of heart. They could be extremely risky, if you don’t know the intricacies behind them. One key factor to keep in mind is the fact you expose yourself to enormous amounts of risk if you buy and hold these products over the long term. That said, I primarily use options to trade volatility products like VXXB to minimize my risk. Now, if you’re interested in learning how to trade volatility and potentially multiply your money, then check out this 30 Days to Options Trading eBook.
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