The Volatility Landscape—May 2013

Friday, May 3rd, 2013 | Vance Harwood
 

News

  • CBOE
    • The CBOE plans to extend VIX® Futures trading by over 5 hours—aligning with the London Stock Exchange open, and adding a 45 minute post settlement trading period 4:30 ET to 5:15 ET Monday through Thursday.
    • Two new volatility indexes, DLVIX and DSVIX are documented on the CBOE website.   These indexes were developed in cooperation with the French bank Société Générale and are now being used with two new European ETFs.   A quick look suggests these indexes switch VIX futures allocations based on term structure and VIX momentum.
    • Volume in VIX Futures continues to surge to record highs with April’s volume climbing 26% higher than March.  The year to year volume growth was 141%.   The chart below shows the open interest on the nearest 2 and the mid-term 4th through 7th month VIX Futures.
1MayVIX-Futures-OI

 

  • VIX Central improved its historical VIX Futures term structure graphs by switching the time axis from contract months to time to expiration.   This change greatly reduces the chances of misinterpreting term structure differences across contract expiration boundaries.  See this post for more information.
  • For the first time an inverse volatility fund—VelocityShares’ inverse short term volatility ETN XIV has taken second place in overall volatility fund assets under management (AUM) with $440 million.  The leader, Barclays’ VXX has $1.15 billion.  Third place goes to ProShares’ UVXY 2X short term volatility ETF with $344 million.  For more on inverse volatility see this post.
  • Yahoo finance now reports Exchange Traded Product (ETP) AUM as net assets in their standard quote information and has made some other information available (e.g. shares outstanding, total cash) with special tickers.   The topics and example tickers shown below for SPDR’s JNK:
    • Intraday Indicative Value   ^JNK-IV
    • Shares Outstanding   ^JNK-SO
    • Net Asset Value ^JNK-NV
    • Estimated Cash ^JNK-EU
    • Total Cash  ^JNK-TC
  • I recently found out about the Quandl data resource—a free source of downloadable price data  futures, stocks, rates, currencies, commodities; macro-economic data from FRED, BEA, DOE, Census, USDA, WB, UN, OECD; demographic and society data; and corporate financials.  There’s a lot of good stuff there.

 

Predictions 

  • With both UVXY and TVIX trading well below $10 per share the question of upcoming reverse splits has returned.
    • I expect ProShares to reverse split UVXY 10:1 in May or June—they don’t want to lose the momentum that they have built up.
    • The last time around (December 2012) Credit Suisse waited until TVIX had dropped below $1 per share before doing a reverse split.  With $188 million in assets, I doubt they’ll let this product fade into oblivion, but given their track record of procrastination I’m guessing we won’t see a reverse split until TVIX is South of $1—perhaps in October / November.

 

White Papers

  • Easy Volatility Investing” by Tony Cooper
    • This paper took 2nd place in the National Association of Active Investment managers’ (NAIIM) recent Wagner Award contest.   It provides a good overview of volatility trading and then does a thorough evaluation of 5 different trading strategies for volatility products: buy & hold, momentum, roll yield, volatility risk premium, and hedged.
  • Option traders use (very) sophisticated heuristics, never the Black-Scholes-Merton formula”   Haug & Taleb
    • I hadn’t seen this 2009 paper until recently.  Taleb claims that the practical impact of the Nobel Prize winning work of Black-Scholes-Merton on the options markets is significantly over emphasized.  He argues that structural relationships like put / call parity and compatibility between options combinations at various strikes (e.g., no negative butterflies) are the true forces setting options prices.
  • Volatility Trading: Trading Volatility, Correlation, Term Structure and Skew” Bennett & Gil
    •  Over 200 pages of wide ranging information—from covered calls to exotic options, to links between CDS spreads and implied volatility.  Something for everyone.

 

Not Recommended:  XXV TVIX XVIX IVOP CVOL XVZ

  • I’ve added Citi Group’s CVOL and Barclays’ XVZ to my “Not recommended” list of volatility funds.
    • CVOL’s assets under management have dropped to $2.2 million and its bid/asked spreads are very wide.  Its strategy of trying to track volatility is sound, and their contango losses are less than UVXY or TVIX, but it’s just too small.
    • The intent of Barclays’ XVZ was to create a fund that was long volatility, but could be held during quiet times without losing much if any money.  XVZ attempted to do this by hedging a position in medium term volatility products with a short position in short term volatility.  Unfortunately for XVZ, the VIX Future term structure shifted about the time the fund was introduced in such a way that the hedging didn’t work and it has lost 30% in the last year.  XVZ might do OK during times of high volatility, but until it establishes some sort of track record in that environment I’d recommend staying away.   For more on XVZ there’s a good article “The Hedge That Wasn’t” posted by Season Investments.


Tracking the VIX Index—CVOL is close, TVIX and UVXY outperform

Monday, August 5th, 2013 | Vance Harwood
 

For a long time investors have been frustrated in their desire to directly invest in the VIX index.  Now three ETNs, one by design, and the two other perhaps by accident are tracking (or out-performing) the VIX index on both a daily percentage move basis and for multi-day holding times.

UBS’ CVOL was designed to correlate well with the daily moves of VIX.   It uses 2X leverage on the 3/4 month rolling volatility futures, and then adds a variable short S&P 500 position to give the ETN some extra kick on down days to better match the VIX. CVOL didn’t use the 1/2 month rolling volatility futures because contango imposes a heavy penalty on them when the markets are quiet—the 3/4 month futures don’t suffer as much. CVOL hasn’t really caught on so far in the market place, its daily volume tends to run below 40,000 shares and its bid/ask spreads are usually in the $0.10 range. The graph below shows CVOL compared to the VIX index on a daily percentage move basis since July 1st, 2011.

Daily percentage moves of CVOL and the VIX index, click to enlarge

Historically the daily percentage moves of short term (1/2 month) volatility ETNs like VXX tend to be about 50% of the VIX index moves. Since VelocityShares’ TVIX and ProShares’ UVXY are essentially a 2X leveraged version of VXX, you might expect it to track the VIX index—and they do a pretty good job except for the effects of contango/backwardation.

TVIX compared to VIX on a daily percentage move basis.  UVXY”s performance is essentially identical to TVIX’s.

Daily percentage moves of TVIX and the VIX index, click to enlarge

While the daily percentage correlation is important, unless you’re day trading volatility (shudder) the more important attribute would be the results of holding these ETNs for a few days. In that case how well would they track to the VIX index? The chart below shows how $1000 invested in each of these starting July 1st,2011 would fare.

July 1, 2011 investment in VIX, TVIX, CVOL, VXX–click to enlarge

CVOL did the best in tracking the VIX index itself. VXX lagged, but eventually caught up due to the sustained period of backwardation for the 1/2 month rolling futures. TVIX on the other hand skyrocketed during this panicky time. A doubled benefit from backwardation was part of the gain, but the trend lines on the chart below suggests there are other factors.  I suspect the rest is from the compounding effects of 2X leverage.

TVIX, CVOL, and VXX, showing trendlines from July 1, 2011–click to enlarge

TVIX and UVXY look like the vehicle of choice if you want to bet on VIX’s moves during times of high volatility—it matches VIX’s daily moves well and greatly benefits from backwardation. On the other hand CVOL is probably the better choice when the markets are less fearful.



Mimicking the VIX index

Wednesday, May 22nd, 2013 | Vance Harwood
 

The Holy Grail of volatility investing would be an ETN or ETF that matched the movements of VIX—CBOE’s volatility index on the S&P 500.   As a hedging vehicle it would be nearly ideal—negatively correlated to fast moves of the S&P 500 with a stable floor during quiet times.  So far no one has figured how to economically offer a fund that does this.  Instead we have a potpourri of choices that sort-of  behave like the VIX  (see volatility tickers for the complete list).  For a detailed discussion of all the ways to go long on VIX see this post.

TVIX and CVOL are the two funds that have come closest to following the VIX in volatile times.   They are both 2X leveraged versions of short term volatility futures, but CVOL includes a short component in the S&P 500 intended to better match the VIX in volatile times.   In the last 10 days these two funds have done a very good job of matching the percentage moves of the VIX.

CVOL and TVIX perform in volatile times, click to enlarge

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The next chart, the 3 month story, shows the dark side of these two funds—a relentless undertow from the contango of volatility futures that makes buy—and—hold a suicide strategy with TVIX and CVOL.

VIX compared to TVIX and CVOL, click to enlarge

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Ugly.  This last chart shows the target—VIX over the last 3 years.   Mimic this and fortune will come to your door.

Three years of VIX, click to enlarge



Under the hood of Citigroup’s CVOL volatility ETN

Friday, December 24th, 2010 | Vance Harwood
 

This baby is built for speed—not distance.

Fortified with several cups of coffee I took on the tough stuff in Citigroup’s CVOL pricing supplement.   The other volatility ETNs (e.g., VXX, VXZ)  limit themselves to various combinations of volatility futures—CVOL adds a variable leveraged short S&P 500 position.  I’ve been wondering why this component was included—I was hoping that it was intended to reduce the negative “roll yields” that have plagued most volatility ETNs.  However my analysis indicates the S&P500 short position is designed to improve CVOL’s  match to the day-to-day moves of the VIX cash index.  A noble goal, but not the one I wanted.

Just using leveraged (2X) 3 and 4-month volatility contracts CVOL would have achieved about a 0.83 statistical correlation with the day-to-day moves of the VIX index in 2010.  Adding the short S&P500 factor boosts that up to 0.86  (anything above 0.7 is considered to be highly correlated).    Unfortunately, at least in 2010, this short position would have resulted in a faster decay than a pure daily roll from 3 to 4 month volatility contracts.  Over 2010 I project CVOL would have lost about 61% of its value, which compares to the year-to-date VIX index dropping 20% and VXX losing 71%.  It isn’t surprising that a short S&P500 position in a rising market hurts.

The modeling

To make this analysis more manageable, and to get around the fact that I don’t have historic data on many of the moving parts of CVOL, I made some simplifying assumptions.   The graph at the end of this post suggests these assumptions didn’t materially change the results.  My simplifications:

  1. I ignored the interest earned putting unused cash in 90 day treasury bills (current yields would produce about 0.4% per year)
  2. The short S&P 500 component used in CVOL includes the cost of dividends that a short position would incur—I ignored the dividend part (currently running around 2% per year).
  3. I ignored the 1.15% per year investor fee (which is assessed daily at 1.15%/365)
  4. Lacking data for the rolling position in 3rd and 4th month volatility futures, I used Barclay’s VXZ ETN—which rolls 4,5,6,7 month contracts.   VXZ probably has less volatility and lower yield roll, but I suspect the differences are relatively minor.

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If you don’t use its S&P500 factor, CVOL’s daily returns compared with the VIX index would look like this for mid October through December 17th:

 

VIX compared to 2X futures, click to enlarge

 

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Not Bad.  But if you add their S&P500 short component (weighting is updated monthly), it looks better still:

 

VIX + 2X futures + S&P short position, click to enlarge

 

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If you could have invested $1K in the VIX index, VXX, and CVOL, at the beginning of 2010 your results would looked something like this:

 

$1K investment starting Jan 2010, click to enlarge

 

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CVOL appears to perform much better than VXX in matching the index, but still suffers considerably from yield roll.   The final graph below adds the actual CVOL prices from its introduction till December 17th.  I adjusted the investment values of the actual vs. hypothetical CVOLs to match at the November 15th introduction.

 

$1K investment with CVOL actuals added, click to enlarge

 

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The path match between CVOL’s actual vs hypothetical values appears to validate that my calculations are fundamentally correct and that my simplifications don’t overly skew the results.   If you are interested downloading the spreadsheet I used for these calculations and these charts visit this post.

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Will CVOL become the next VXX?

Friday, December 24th, 2010 | Vance Harwood
 

When Barclays ‘ VXX ETN first came out early last year I was pretty excited.   Having an direct investment in a volatility product that didn’t have the time decay (theta) of VIX options was attractive.   However, it turns out that price erosion on VXX is a huge issue—anyone that holds on for the long term becomes a loser.    In spite of this, VXX has become a huge success, with an average volume of 9 million shares a day.

It’s way too early to tell, but Citigroup’s CVOL ETN is showing much less susceptibility to price erosion than VXX.   Since November 15th, when CVOL started trading the VIX index has dropped 13.35%,  VXX has dropped 18.5%, and CVOL, adjusted for its 2X leverage  has dropped 12.7% —slightly less than VIX!    Adjusted for its 2X leverage CVOL is not showing as much pop as VIX on big swings, but I would gladly give that up to avoid ongoing price erosion.  If CVOL can keep this up, there will be little reason for investors to stick with VXX.

CVOL’s pricing supplement / prospectus