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Short VIX ETNs: Pricey Precision

Paul Britt

Because the CBOE Volatility index isn’t directly investable, investors must access the VIX through the futures market. The ETRACS suite, which is backed by UBS, offers precise exposure to the VIX futures curve in one-month increments across six months. Here are the six inverse versions:

  • ETRACS Daily Short 1-Month S'P 500 VIX Futures ETN (NYSEArca:AAVX - News)
  • ETRACS Daily Short 2-Month S'P 500 VIX Futures ETN (NYSEArca:BBVX - News)
  • ETRACS Daily Short 3-Month S'P 500 VIX Futures ETN (NYSEArca:CCVX - News)
  • ETRACS Daily Short 4-Month S'P 500 VIX Futures ETN (NYSEArca:DDVX - News)
  • ETRACS Daily Short 5-Month S'P 500 VIX Futures ETN (NYSEArca:EEVX - News)
  • ETRACS Daily Short 6-Month S'P 500 VIX Futures ETN (NYSEArca:FFVX - News)

 

There’s also a companion set of long VIX ETNs with similar exposure. Taken together, this suite of products provide sophisticated investors with the tools to replicate strategies that until recently were probably only available in hedge funds.

The prospectus for these ETNs makes two points emphatically that bear repeating here. First, they’re designed for short-term use only. And second, they’re aimed squarely at traders.

Costs

The ETNs cost 1.35 percent a year, plus an additional fee called an event-risk weekly hedge cost. The fact sheet clearly states the hedge cost as 0.077 percent a week. This works out to 4.10 percent a year by my math. This makes an all-in cost for the year at 5.45 percent. (A Ron Rowland article called out this high cost last month.)

You’ll notice my lack of exclamation points above. While this cost is huge in absolute terms, I really do expect that the people who use these products only hold them a short while. I’d also say that anyone holding a volatility ETN—or any other product that resets daily—for a year has a lot more at risk beyond a 5 percent haircut from fees.

Still, high direct costs can’t be ignored. While users of sophisticated products like this probably take a position for only a few days, they might do so repeatedly and consistently over the course of the year. In this respect, the annual cost may loom larger in their profit-and-loss than might otherwise be implied by a 7.7 basis point weekly charge.

e’ve talked only about direct costs so far. But traders probably focus more on execution costs. Thin volume and wide spreads sometimes go hand in hand with new products like these. Fat spreads can add significant expense to getting in and out quickly. In other words, look before you leap.

Choices

ETRACs offers the only suite of products that covers the whole VIX futures curve from one to six months.

Note, however, that you can buy identical exposure to the one- and five-month futures without paying the hedge fees.

For example, the VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca:XIV - News) tracks the exact same index as UBS’ AAVX. And the VelocityShares Daily Inverse VIX Medium-Term ETN (NYSEArca:ZIV - News) aims to match the same index as EEVX.

XIV and ZIV have the same 1.35 percent expense ratio as the two ETRACS ETNs. But, crucially, XIV and ZIV lack the hedge fee.

Pro users will have to compare for themselves the all-in costs of these ETNs versus direct trading in VIX futures.

 

 

 

Transparency

I think the ETRACS folks do a reasonably good job of highlighting the unique nature of their ETNs.

Page one of the prospectus essentially states in bold print that if you don’t know what contango means, this isn’t the place to learn. It also clearly warns that these are not buy-and-hold products.

But it’s less than ideal that the expense ratio—ETRACS calls it a “tracking fee”—is presented as an annual figure and the hedging expense as a weekly measure. After all, both of these expenses are time-based and charged at their equivalent daily rates.

On the fact sheet, only the low weekly figure shows up. You have to go to the prospectus to see an annual figure.

The hedge fee doesn’t show up at all on the Bloomberg DES (description) screen either, so pro users wouldn’t catch it there.

Pro Tools

These ETNs seem tailored for strategies that combine different exposures to the VIX futures curve:long one month, short another, maybe long or short the S'P to boot. If you’re swimming in this pool, you know far more about it than I ever will.

My point is to reiterate that these ETNs serve as tactical tools:short-term building blocks for those with explicit, strong and precise views on the VIX futures curve.

These strategies were once confined exclusively to hedge funds. Whether retail folks should even be allowed to access them is a separate, but important, question.

They’re dangerous in the wrong hands. But so are chain saws, and Wal-Mart sells those every day. I’m sure I don’t want my mom near either of them.

 

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