Stocks quoted in this article:
Well, the world officially can't get enough of the VelocityShares Daily 2x VIX Short Term ETN (TVIX). I mean, at first, the world literally couldn't buy enough TVIX, hence the original halt in creating new TVIX shares. Now, the world can't get enough of the TVIX story.
Even the powers-that-be want to take a peek, as Reuters reports:
A spokeswoman for the Financial Industry Regulatory Authority said Thursday the regulator is "looking at the events and trading" activity surrounding a sharp plunge in the price of an exchange-traded note designed to track stock market volatility.
FINRA began its inquiry after the Credit Suisse-managed VelocityShares Daily 2x Short-Term exchange-traded note, or ETN, lost half its value in just two days earlier this month.
But FINRA's review is not limited to the volatility ETN, the spokeswoman said. "We have a review underway looking at a host of issues relating to ETNs and other complex products," the spokeswoman said.
There's an old saying about "closing the barn doors after the horses have left" that comes to mind here. I mean, seriously -- TVIX halted creations for a month and the shares ballooned to nearly double their net asset value (NAV). It was a relatively well-publicized time bomb waiting to explode. If you want to examine how this product got approved to begin with, fine. If you want to take some action after the creation freeze, that's fine, too. But waiting for the inevitable conclusion to play out and damage investors, and then taking an interest, is beyond weak.
It's too late for investors like this, described in a recent Wall Street Journal article:
But individual investors such as Eric Brehm, owner of a medical-supply distribution business in Sunnyvale, Texas, were in the dark. Back on Feb. 22, he had bought 2,200 of the shares for $17.30 each. It "was a way to hedge if the market took a big drop and offset my losses in other securities," the 59-year old Mr. Brehm said.
Unfortunately, nothing can help an investor like that. If you're buying a double-leveraged VIX ETF to offset losses in other securities, you're doomed to failure to begin with. I hope all of us have drummed home the lesson that volatility ETFs drift over time, thanks to a near-constant state of contango in VIX futures, and tracking ETNs will magnify that underperformance, thanks to the laws of compounding. Even at NAV, TVIX is an awful security to put in the vault.
The SEC certainly bears some responsibility, but so does the investor. I mean, no one expects everyone to read every prospectus, but they do expect everyone to have some modicum of knowledge about what they trade. Did anyone holding TVIX for that month remotely question why it outperformed the identical (albeit less popular) UVXY, VXX itself -- or even the VIX, for that matter? If something seems too good to be true, then it's probably not true.
So, what is the solution? David Nadig of Index Universe has this to share:
The solution is gating.
If Eric wanted to open a futures account and trade VIX futures, he’d need to clear an hour off his schedule.
He'd have to read and sign a piece of paper saying he'd read and understood a rather lengthy set of risk disclosures from the Commodity Futures Trading Commission. So why should he be able to invest through a backdoor in those exact same futures through TVIX or another volatility product like the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX)?
He shouldn't be...
Instead, ETFs should go through a review process that actually categorizes them based on their risks, exposures and complexity. Products that cross certain lines -- leverage, derivatives use, path-dependent fees -- should be put behind a separate set of disclosures.
This idea certainly has some merit. I don't have an account to trade futures, nor do I have any sort of license. But I synthetically trade VIX futures, anyway, via VIX options. I'd like to think I'm qualified to do so; I've spent 20 years trading options and/or writing about trading options. But as of now, you don't actually have to learn what you're trading to jump in on these ETFs and ETNs. So, this "gating" approach sounds like a good idea. Put up some barriers, before letting anyone and their medical-supply dealer just jump on in.
I wouldn't even make the test that difficult:
- Define realized (or historical) volatility.
- Define implied volatility.
- Find the current 20-day historical volatility and 30-day implied volatility in the S&P 500 Index (SPX).
- Explain how a VIX future works.
- Tell me what VXX does.
- Describe the mechanics of a 2x leveraged tracking ETF, like TVIX, and how it will perform over time vs. the ETF it tracks.
And if you have a handle on all of that, hey -- go trade yourself some TVIX!
Disclaimer: The views represented on this blog are those of the individual authors only, and do not necessarily represent the views of Schaeffer's Investment Research.