Large inflows into VIX-related exchange-traded products are amplifying distortions in VIX short-term futures prices, and market participants are pitching ways to take advantage and wondering whether the distortion might become a problem. The distortions were pointed out by Marko Kolanovic, head of equity derivatives strategy at JPMorgan on a panel at the Chicago Board Options Exchange Risk Management Conference in Bonita Springs, Fla., today.
Two-times leveraged volatility exchange-traded products, especially, seem to be the prime cause. In order to manufacture the leverage, issuers must sell front-month VIX futures and buy longer-dated VIX futures at two times the notional invested. Some offer daily rebalancing, which means the flows are continuous and cannot be managed by the rest of the market as a date-specific rebalancing could.
Credit Suisse’s two-times levered vol ETN, the TVIX, is an example of the product. The firm suspended creation of new TVIXX units on Feb. 22, “due to internal limits on the size of the ETNs.” From December to that point, outstanding shares in the product moved from under 10,000 to 40,000 shares outstanding. In that same time and almost in lockstep, the beta of VIX futures rose from 0.2 to about 1.3, according to a graph exhibited by Kolanovic. A beta of greater than one means the volatility of the underling will be greater than that of the market.
Kolanovic did not call the VIX-related ETPs a problem, but was using the trend as one piece of evidence for a changing equity volatility environment. He and others at the conference told DI the occurrence meant dealers and buysiders would likely look to sell front-month volatility.
The conference was populated with numerous exchange-traded product issuers. An official from VelocityShares, which created the TVIX and issues two-times levered vol ETPs, disputed the notion to DI that these products have been the primary drivers.
The TVIX investments come from investors who are concerned that a market event is imminent. Kolanovic noted on the sidelines that if nothing occurs over the next month or two, many investors will likely drop their shares.
A hedge fund portfolio manager opined that it is “too early to tell” whether the inflows into the products are a problem, but added “come back next year and it may be the big issue.”
