Volatility has emerged as an important asset class in its own right over the past decade. Book-ended by two equity bear markets, the past decade (2000 – 2010) saw heightened financial stresses and large losses in investment portfolios. The investment community’s need for tools and instruments to protect downside risks had never been more acutely felt. As the saying goes, necessity is the mother of invention, and this sentiment holds true in the realm of financial engineering.
Since its introduction in 1993, the VIX, the Chicago Board of Options Exchange’s (CBOE’s) volatility index, has become widely considered the “fear gauge” of the market. The VIX measures the implied volatility of S&P 500 index options, representing the market expectation of stock market volatility for the next 30 days. Market participants quickly discovered the value of the VIX index in hedging portfolio risks, since the VIX was found to be negatively correlated with the returns of the equity market, as measured by the S&P 500. Furthermore, the level of correlation increases as the equity market sells off. Due to this asymmetry in correlation, the VIX is an ideal hedge for a long-only equity portfolio.
Recognizing the importance of the VIX index, a host of new products based on the VIX were introduced in the past decade. In 2004, the CBOE Futures Exchange (CFE) introduced futures trading on the VIX, and the CBOE listed an options contract on the VIX in 2006. In 2009, S&P Indices introduced the S&P 500 VIX Futures Index Series, which is now the basis for a growing list of more than two dozen ETNs and ETFs, linked to more than US$ 2 billion in assets (Liu and Dash, 2011). These instruments have driven the VIX’s evolution from a market indicator to a hedging vehicle.
VIX ETPs Demystified – December 2011
Just like most humans (monozygotic twins excluded) are not created equals, most VIX futures based exchange-traded products (ETPs) are not equal (At the time of writing this post, there were 43 primary listed ETPs). While there are a number of distinctions and I will attempt to highlight the key areas, but first the few common themes are:
1) They all use swaps to some degree
2) They are all linked to VIX futures (and maybe other assets, but not VIX spot or the VIX Options)
This is not to say that these are the only commonalities, but these are among the most important ones. The key areas of differences for these ETPs are:
1) Structure – These can be structured as exchange-traded notes (ETNs) or exchange-traded funds (ETF), depending on the issuer. Depending on the structure, there may be certain provisions that would be imposed on the investor. e.g. ETNs tend to have an automatic acceleration provision that initiates redemptions if certain trigger thresholds are breached.
2) Exposure – The exposure can vary by maturity i.e. 30-day, 60-day, 5-month, etc.; overcome certain investment impediments such as to reduce roll cost like Term Structure or Dynamic VIX Futures; or for use as an asset allocation tool.
3) Issuer/Sponsor – A number of product issuers globally are offering products – Barclays Capital (through iPath or Barclays ETN+), VelocityShares, ProShares, UBS (Through E-TRACS platform), Source (in Europe), Kokusai Asset Management (in Japan), Citigroup and BetaPro (in Canada)
4) Fees – The fees for different products offered by different sponsors varies. An investor should look through the prospectus to identify “all-in” cost prior to deciding which product to use.
Click here to view the file which lists the 43 products and outlines their structure, AUM, and other high-level characteristics of these products.
Education, VIX
ETPs, ProShares, UBS, VelocityShares, VIX, VIX Futures