XXV: Dancing the contango—without getting mugged

Sunday, August 17th, 2014 | Vance Harwood
 

Update

I do not recommend XXV.  At its current price of around $30/share  it does not deliver the sort of performance you would expect an inverse volatility security to deliver.   This security can go no higher than $40 per share and can only get there slowly.  See this post for more information.   If you want to be short volatility use XIV or SVXY.

Original Post

The inverse volatility ETN XXV has gained over 50% in the 70 trading days since Barclays introduced it.   However, far from lighting up the investment community the interest in XXV  has been moderate, with an average daily volume in October of 231 thousand compared to 31 million for VXX—its inverse.

If you’ve been paying attention, you know that VXX ( which not surprisingly has lost over 50% in the same period) suffers from two major maladies:

  1. The VIX index, on which the VXX is based (via volatility futures) tends to drop towards the 10 to 15 range when the market is going sideways or up.  There is no prospect for sustained, long term growth.
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  2. The VXX ETN must continually update its portfolio to include more longer dated futures and fewer short term futures.    Longer dated volatility futures are almost always more expensive than short term, so the VXX operators are continually buying dear and selling cheap.   In commodities markets this higher price structure for longer dated contracts is called contango

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With two strikes against VXX, why aren’t people buying XXV, or just shorting VXX?

If these two ETNs were people, VXX might be a depressed alcoholic artist that has occasional bouts of brilliance,  whereas XXV might be an overperforming sales person that normally blows through sales quotas, but occasionally disappears for a couple of weeks and then calls asking you to post bail.

If you want to invest in XXV you should have a pre-disappearance sell strategy.  XXV already has a doomsday $10 “termination event” stop loss built into it, but with XXV currently above 30 a loss limited to 66% or more is not comforting.

A trailing stop strategy is attractive, with perhaps a 2% trigger, but a key requirement for a stop loss order to work well is an orderly market when things are dropping.   If the XXV price gaps down in bad times then a trailing stop order would not offer the protection it implies—potentially filling at a much lower price than 2% off its high.

Evaluating XXV’s behavior during the May 7th Flash Crash would be a great test—except XXV didn’t start trading until July 19th.

Not easily deterred, I synthesized an approximate XXV chart for all of 2010 using VXX intra-day high data.   I used the intra-day highs, because that would map to the intra-day lows in XXV that would potentially trigger a stop loss order.  I didn’t try to include the impact of XXV’s .89% yearly fee in my calculations.

Comparing the chart of the actual XXV values (purple) against my synthesized chart (green) suggests this approach is valid.

The May Flash Crash and subsequent market correction would have dropped XXV to around 15, but would not have tirggered the $10 doomsday stop loss.    The market uncertainty preceding the Flash Crash would have tripped a XXV position’s 2% trailing stop around April 27th, and the rising $VIX would have kept a prudent investor out of XXV until well after the volatility fireworks died down.   In summary, a trailing stop type approach looks like good way to protect an investment in XXV.

This same analysis should apply for just being short VXX, however my broker rarely has VXX available to short, and with an IRA account you can’t sell equities short, so XXV is the best option for me.



XXV behavior—it’s a pretty good VXX short

Sunday, November 24th, 2013 | Vance Harwood
 

Update: I do not believe XXV is a good way to short VXX, or volatility in general.  It has very little upside remaining (maximum value will be $40/share),  see this post for more details.

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With the recent action in the VIX and VXX I thought it would be good time to go back and check the performance of Barclays’ new ETN product XXV to see how it is performing.

 

 

 

XVV — VXX short or percentage move, click to enlarge

 

Clearly XXV is intended to perform like a short of VXX.  With a little imagination you can foresee that on-going charges will prevent a perfect match, but after nearly two months my hypothetical true short of VXX vs XXV is tracking  with only about a 1% lag—impressive.

With VXX fighting a big contango headwind XXV is looking like a pretty attractive investment.



XXV Prospectus

Monday, January 10th, 2011 | Vance Harwood
 

Update: I do not believe XXV is a good way to short VXX, or volatility in general.  It has very little upside remaining (maximum value will be $40/share),  see this post for more details.

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XXV Prospectus:   XXV:  Barclays Inverse VolatilityETNs

Usually getting the prospectus for a new ETF or ETN takes a Google search and a couple minutes of browsing.  The prospectus for Barclays’ new XXV inverse volatility ETN proved to be a much more elusive search—it didn’t show up in the top 20 hits.   Reading through the fine print of the XXV Fact Sheet provided this pointer for web access:

Before you invest, you should read the prospectus, prospectus supplement, pricing supplement and other documents Barclays Bank PLC has filed with the SEC for more complete information about Barclays Bank PLC and this offering. You may get these documents for free by visiting EDGAR on the SEC website at www.sec.gov.

Even finding the prospectus on EDGAR proved to be frustrating.  My search in Edgar’s company search for  “Barclays Bank PLC”  resulted in a  lot of hits, but 20 minutes of clicking did not yield anything XXV related.    I finally did an  EDGAR text advanced search with XXV as the text and Barclays Bank PLC as the company to find the XXV prospectus and a few other related documents.

I have only started to dig through this 66 page document, but so far the most interesting aspect of XXV is its “Automatic Termination Event”—which liquidates your position if the intraday indicative note drops to $10 or less.   I don’t know of any other ETN or ETF that includes a built in stop loss order like this.   XXV is effectively a short of VXX, and as investment writers are fond of reminding us, a short position can theoretically result in “infinite” losses.  The people at Barclays have decided to block the infinite losses scenario  by limiting an investor’s potential maximum loss to be whatever they invested minus around $10 per share.

Somewhat sobering, the prospectus finishes the section on Automatic Termination Event with:  “If the historical frequency of precipitous increases in market volatility persists, it is highly likely that an automatic termination event will occur”.

This is probably not an investment that you want to buy and hold…

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Prospectuses for a couple of other volatility based products:

CVOL’s pricing supplement / prospectus

XVIX E-Tracks Long-Short  prospectus



Going short on VIX?

Thursday, October 9th, 2014 | Vance Harwood
 
Unlike the S&P 500 or Dow Jones Index there is no way to directly invest in the VIX index.  I’m sure some really smart people have tried to figure out how to go long or short on this computed volatility index, but currently there’s just no way to do it directly.  Instead, you have to invest in a security that attempts to track VIX.  None of them do a great job of this.   I’ve given a short answer and a long answer below on how to best short the VIX given the current choices.  Take your pick.
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Short Answer
  • Buy VelocityShares’ ZIV inverse medium-term volatility.   This product follows general volatility trends, but doesn’t have the neck snapping moves of the short-term based products.   You definitely still want to exit if the market volatility starts climbing, but you have more time to react.   In the post Timing Inverse Volatlility with a Simple Ratio I provide a straightforward method to time your ZIV entries / exits.
  • If you want to aggressively short on VIX buy VelocityShares XIV or ProShares SVXY
    • XIV & SVXY attempt to match the opposite percentage moves of VXX.  Since VXX only manages about 50% of the VIX’s percentage moves you should expect XIV to have a similar behavior.  For more on XIV see this post.

Long Answer

The  current set of securities that attempt to track or provide the inverse of the VIX index include:

  • Volatility futures contracts  (CBOE VIX Futures)
  • Options on volatility contracts (CBOE’s VIX options)
  • VXX & VXZ ETNs with theirVelocityShares, ProShares, and UBS investment bank competitors (rolling blends of futures contracts that trade like stocks). See this post for a complete list.  See  How to short VXX for specifics on shorting VXX.
  • Options on VXX, VXZ, UVXY, SVXY
  • Inverse funds that attempt go up when volatility goes down
    • VelocityShares’ XIV ETN  (goal—daily short term inverse returns).  Looks like a good vehicle for this.  More info here.
    • ProShares’ SVXY ETF  (goal—daily short term inverse returns).  This is the only Exchange Traded Fund (as opposed to a Exchange Traded Note) in this area.
    • VelocityShares’ ZIV ETN  (goal—daily medium term inverse returns).   More info here.
    • Barclays’ IVOP ETN  (short of VXX that started trading 16-Sept-2011).   More info here.  Not Recommend—low leverage.
    • Barclays’ XXV ETN (short of VXX that started trading 19-July-2010).  Not recommended—very low leverage.  More info here.
  • CVOL (leveraged blend of futures contracts plus short S&P500 position). More info here.

All of these choices can be at least theoretically used to bet that the VIX index will go down.  Futures contracts or VXX can be shorted, VIX or VXX puts can be bought, or calls shorted, and XIV can be bought directly.

All of these choices have significant problems.

  • None of them track the VIX index particularly well, they tend to lag the index considerably
  • VXX can be hard to short (Schwab has had it in their “Hard to Borrow” category for a long time) and you can’t short stocks / ETFs/ETNs in an IRA account.  Fortunately XIV, SVXY, and ZIV are available,
  • Long VIX / VXX options have serious time decay issues—if the VIX doesn’t drop when you expect your positions bleed money.
  • Because volatility products are relatively volatile the premiums on options tend to be expensive.
  • Unhedged short positions leave you exposed to losses larger than your initial investment if you forecast incorrectly.  Your losses if the index spikes won’t be unlimited because nothing goes up infinitely, but it could be enough to really hurt.  Even the lethargic VXX managed rallies of around 2X in 2010 and 2011.

On the positive side of betting that the VIX index will go down, the VIX index and all of its proxies show mean reversion.  After it spikes up, fear always subsides, and any surviving short position would reduce its losses over time and potentially turn profitable—assuming you didn’t get in when the VIX index was really low.

Better yet, short positions on VXX or similar products will also profit from the contango associated with the volatility futures these products are based on.

If you decide you want to go short on the VIX index, I think it makes sense to limit your potential losses if volatility spikes, either with stop loss orders, or with VIX or VXX OTM calls that would really kick in to limit your losses.  Stop loss orders are scary because if the market is gapping you might lose quite a bit more than your stop loss order would suggest.   For example if you are short VXX at 40 and your stop loss is set at 42, your order might fill at 44 if the market gaps down significantly at opening.   The type of stop loss order that becomes a limit order rather than a market order when triggered prevents this scenario, but opens you up to an even worse loss if volatility continues to spike and never trades at your limit price.

Even though it is scary, I think a stop loss order would probably work well. At least looking back over the last couple of years, including the flash crash, the market was orderly enough to prevent large losses if reasonable stop loss orders had been in place.