Regardless of whether it made it to the front page of your business section, the biggest news story by far over the last two trading days has been the collapse of the VelocityShares 2x Daily VIX Short Term Exchange Traded Note (TVIX), invariably referred to as the T-Vix ("Tea-Vicks").
The Exchange Traded Note, or ETN, was issued by Credit Suisse (CS) and designed as a vehicle for trading the volatility of the S&P 500 (^VIX) on a levered basis. In theory, if the VIX rose 10% in a day the TVIX would gain twice that amount.
Over the last two days the TVIX lost over 40% of its value. The implosion of the TVIX casts a light on the murky underbelly of the ETF and ETN industry.
Lee Munson and Jon Najarian, among other Breakout guests, have previous discussed concerns over ETFs and ETNs.
Najarian, the co-founder of TradeMonster.com gave me his thoughts on how levered products work in general and the the TVIX collapse in particular via email this morning:
"ETFs and ETNs are fairly vanilla products, they do what they're supposed to do, track performance of an index, future etc.
All that changes with these levered ETFs & ETNs. With those the price resets every single day. As a result, if you hold during a 30 percent market move that unfolds over 3 to 6 months, the levered ETF or ETN will NOT track that change.
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!
Credit Suisse ceased creation of the notes on February 21st. [In effect ceasing to be a market maker of the TVIX, allowing them to disconnect from any hypothetical underlying value]. Both the creation issue and the daily reset are to blame for the TVIX. The crazy pricing and trading of that ETN since Credit Suisse stopped creating the TVIX caused them to hold a value significantly higher than was warranted until the past two sessions when the ETN fell to earth."
Credit Suisse bears much of the blame for what happened to the TVIX, but investors had ample warning. The firms itself laid out many of the risks on page one of the TVIX prospectus, noting that the ETN:
"Should be purchased only by knowledgeable investors who understand the potential consequences of investing in volatility indices and of seeking inverse or leveraged investment results, as applicable"
"May not be suitable for investors who plan to hold them for longer than one day"
"In almost any potential scenario the Closing Indicative of your ETNs is likely to be close to zero after 20 years."
Investors ignoring the warnings of the TVIX issuer itself could have found prescient insights from Adam Warner, FT Alphaville.com or any number of other sources.
The TVIX disaster is appalling and an embarrassment to all of Wall Street, but it was avoidable for investors. If you didn't avoid this nightmare you need to learn from it anyway.
Too many people are rushing into these poorly designed instruments and getting hurt. The burden is on regulators to make these problems go away but it's also on individuals to understand what they're buying and selling.
There is no free lunch on Wall Street or anywhere else. Don't trust anything you're being told or sold with your own money. Don't wait for the SEC to come in and do your homework; protect yourself by doing the research before you get TVIX'ed.
