ProShares was the first Exchange Traded Fund (ETF) provider for volatility based funds. The previous volatility entries from Barclays (e.g., VXX & VXZ) were all Exchange Traded Notes (ETN). Click on the underlined ETF / ETN for discussions on how these types of securities work. Proshares has done well and currently has the most assets in the volatility ETP space.
UVXY (1.5X long) and SVXY ( -0.5X inverse daily percentage long) track the SPVXSP index which specifies a mix of the two next to expire VIX futures to give an approximate 30 day effective time until expiration. These funds are large enough that their bid/ask spreads and liquidity characteristic are very good.
Some salient characteristics:
- UVXY and SVXY have options available
- Tax treatment: Because UVXY and SVXY explicitly hold VIX futures the IRS counts them as partnerships that need K-1 forms filed for taxable accounts at tax time. The VelocityShares ETN’s tax treatment is the same as regular stocks. On ProShares’ website (point 1) they elaborate:
- K-1 reporting: With volatility, commodity, currency, and managed Futures ProShares will invest in a range of derivative instruments, including futures and forward contracts. In general, open futures positions will be marked to market, with their capital gains and losses reportable on a Schedule K-1. The reporting of gains and losses may vary depending on the specifics of a contract. See here for more on K-1 tax reporting and the ability to access your K-1 reports on-line if you have held ProShares volatility ETFs.
- This income (loss) might be categorized as under 1256 contracts. These generally result in 60% long-term and 40% short-term gains/losses on the investor’s tax return regardless of how long you held the shares.
- Credit risk: Because ETF’s explicitly hold the underlying futures and swaps contracts that track the index their credit risk is lower than an ETN’s. With ETN’s you are essentially depending on a single company (e.g., Barclays in this case) to honor their debts. Barclays is a big banks with a good credit rating, so I think this risk is pretty small. See ETN Credit Risk for more information.
- Termination risk: With ProShare’s funds I can’t find any mention of termination criteria in the prospectus, except for the generic, “we can terminate whenever we want” clause. With a -0.5X short daily percentage volatility fund it would take more than a doubling of volatility on the long side (e.g., VXX ) to wipe out the short side. My assumption is that ProShares would terminate SVXY rather than allow its NAV to go negative.
For a complete list of available volatility, ETFs and ETNs with links to associated indexes and information see Volatility Tickers.