“People are likely shorting the TVIX and creating the underlying portfolio by buying the VIX futures to hedge,” Michael McCarty, managing partner at Differential Research, told Bloomberg. “That will cause the premium to contract.”
Volatility exchange traded products are designed to follow VIX futures contracts, rather than the spot price. Adding further complexity, some are ETNs and some are ETFs.
A key difference between the products is that ETNs introduce credit risk because they are debt obligations issued by financial institutions that promise to pay the return of a particular index.
Other exchange traded products designed to rise with VIX futures include iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) and ProShares Ultra VIX Short Term Futures ETF (NYSEArca: UVXY). They were down fractionally before Friday’s opening bell.
Paul Justice, director of North American ETF research at Morningstar, in a newsletter earlier this month said there was a “fear bubble” in volatility products.
“Irrational exuberance has taken hold in volatility investments. The category gained $1.52 billion in February. Total assets in the category grew by 42% last month and now stand at $3.6 billion,” Justice wrote. “Inflows were so strong that TVIX has suspended new creations. But that hasn’t stopped investors from chasing after it: Investors still demanded it enough to push its price to a … premium over its net asset value.”
He warned: “To me, this is a $3.6 billion disaster waiting to happen.”
Any investors who are using volatility-linked exchange traded products as long-term portfolio hedges are getting hurt by so-called contango in the VIX futures market. [VIX ETFs: Beware Contango]
VelocityShares Daily 2x VIX Short-Term ETN
