A $61M Trade on One of the Worst Products Ever Created

A massive put buy on ProShares Trust Ultra VIX Short Term Futures ETF (UVXY) may have influenced iPath S&P 500 VIX Short-Term Futures ETN (VXX)

Mar 25, 2015 at 8:50 AM
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Maybe there was more to Friday's iPath S&P 500 VIX Short-Term Futures ETN (VXX) blip than meets the eye:

The CBOE Volatility Index (VIX) sonar video seems to have disappeared into the ether. But here's the deal -- about the same time as the VXX fireworks, a player bought 120,000 January 2017 9-strike puts in ProShares Trust Ultra VIX Short Term Futures ETF (UVXY) for $5.10.

UVXY is more or less identical to VelocityShares Daily 2x VIX Short Term ETN (TVIX). It tracks two times the VXX, but it's an exchange-traded fund (ETF), whereas TVIX is an exchange-traded note (ETN). Other than that fun time when TVIX stopped creating new shares for a couple weeks and sat above net asset value -- then started creating shares again, and promptly imploded -- they move in unison. And by unison, I mean "drift to zero."

These pups are basically the worst products ever created. VXX drifts lower over time, as we all know. Trackers also tend to drift lower on their own, thanks to compounding. A tracker can actually outperform over a specific time frame if the "trackee" makes a trend move. But since VXX always trends down over the long haul, all that means is that TVIX and UVXY trend down even faster. Throw in the two times leverage, and you have a perfectly horrendous hold. They may explode up in blips, as VXX does occasionally pop. But over time, they will go towards zero.

UVXY is near $15 as I type. So in a vacuum, paying $5.10 for these puts seems nuts. That's a $61.2 million dollar investment. For it to pan out, UVXY will have to go below $3.90 in 22 months. That's more or less three-fourths of its current "value" … but I hereby predict the buyer makes a profit.

Back in the here and now, I'm not sure I get the cause and effect between this trade and the VXX action on Friday. Someone (probably multiple someones) filled the UVXY put buy. So they're now long UVXY, which you can convert to a de facto long in VXX. So the "effect," on the margins, should be to knock VXX down. But it was the opposite -- VXX blipped up.

Clearly there was a connection, as it all took place at the same time. Maybe the same party entered the order simultaneously? If so, nice trade by the "locals," though I'm not sure at the end of the day that a VXX short really hedges a LEAPS put sale in UVXY all that well.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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