Trading, Profits, and Volatility in a Dynamic Information ...
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Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 1
Trading volatilityAt what cost?
TVIX
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 2
Trading volatilityOutline:
VIX futures and options marketsWhy trade volatility?VIX ETP market
Product offeringsTransparencyPerformanceDestabilization of VIX futures marketAt what cost?
VIX futures and options marketsCBOE started reporting in January 1993. VIX derivatives launched more than decade later.
VIX futures launched by CBOE Futures Exchange in March 2004.VIX futures options launched in February 2006.
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 3
VIX futures and options markets
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VIX futures and options markets
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Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 4
Why trade volatility?Risk management
Take directional view on market volatilityFundamental economics analysis
Why trade volatility?
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1/2/1986 6/25/1991 12/15/1996 6/7/2002 11/28/2007
VIX
(%)
August 1990: Iraqinvades Kuwait
January 1991: US beginsmilitary action in Iraq.
October 1997 and August 1998: DJIAexperiences record losses. September 2001:
Terrorists attack World Trade Center.
April 2011: S&P downgrades US credit rating.
October 2008: Credit market collapse.
October 1987: Stock market crash
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 5
Why trade volatility?Risk management
Take directional view on market volatilityFundamental economics analysisStatistical analysis:
Implied volatility is mean-reverting.Deviation of implied volatility from realized volatility.
Hedge volatility exposureBuy calls to hedge “tail risk.”
Diversify.Use collateralized futures position to create new asset class.
Why trade volatility?Focus on diversification.
Maximize Sharpe ratio.
Note negative expected return for MT index.
S&P500 MSCI VIX MTExpected return 12.0% 10.0% -4.0%Expected volatility 24.4% 23.3% 32.2%Expected correlations
S&P 500 1 0.515 -0.776MSCI 0.515 1 -0.469
VIX MT -0.776 -0.469 1
Risky asset return/risk parameters
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 6
Why trade volatility?Optimal allocation is
28.74% of portfoliois invested in VIX MT futures volatility index.
-10%
-5%
0%
5%
10%
15%
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25%
0% 5% 10% 15% 20% 25% 30% 35%
Expe
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Volatility
Fractional weights 0.5192 0.1934 0.2874Maximum slope 0.5893Expected return 7.01%Risk 10.21%
Final risky asset portfolio
Why trade volatility? (Ogilvy station)
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 7
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
About as active as Ford shares
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
As big as small S&P 500 stock
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 8
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
Management fees
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
S&P VIX futures indexes used as benchmarks.
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 9
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
Leveraged and inverse products
VIX ETP marketProduct offerings (March 30, 2012)
30 different ETPs8 most active are:
Average Asset value Date of Yearly Inst.Symbol Name volume in USD millions inception fee ST/MT TR/ER Factor owner.VXX iPath S&P 500 VIX Short Term Futures ETN 32,104,131 1,864.6 20090129 0.89% ST TR 1 30.4%TVIX VelocityShares Daily 2x VIX Short-Term ETN 13,344,642 355.7 20101129 1.65% ST ER 2 1.0%XIV VelocityShares Daily Inverse VIX Short-Term ETN 7,739,089 446.9 20101129 1.35% ST ER -1 40.6%UVXY Proshares Ultra VIX Short-Term Futures ETF 1,478,367 125.4 20111004 0.95% ST ER 2 30.4%VXZ iPath S&P 500 VIX Mid-Term Futures ETN 467,066 320.1 20090129 0.89% MT TR 1 38.0%VIXY ProShares VIX Short-Term Futures ETF 273,392 127.9 20110103 0.85% ST ER 1 22.3%SVXY Proshares Short VIX Short-Term Futures ETF 111,773 29.1 20111004 0.95% ST ER -1 5.0%VIIX VelocityShares VIX Short-Term ETN 91,465 35.0 20101129 0.89% ST ER 1 14.9%
Benchmark
Institutional ownership
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 10
VIX ETP marketMarket value of largest 8 VIX ETPs
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VIX ETP market: TransparencyETPs should be fair and transparent buy-and-hold investments.
Futures and options markets have restricted access. Must sign detailed risk disclosure statements indicating in deep knowledge of risks.Stock markets have low-cost public access and traders are less sophisticated on average. VIX ETPs are complicated VIX futures trading strategies. Should they be allowed to trade as shares of stock?
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 11
VIX ETP market: PerformanceHow well does VXZ track S&P VIX MT futures index performance?
Summary statistics:VXZ SPVXSTR
n 773HPR -45.93% -44.46%Volatility 31.78% 32.05%
Regression: VXZ on SPVXSTRα t(α ) β t(β ) R2
-0.00006 -0.33 0.95812 103.72 0.9331
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S&P VIX MT
Less than one basis point.
VIX ETP market: PerformanceHow have S&P VIX indexes performed since inception in 20051220?
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VIX ST futures index VIX MT futures indexST ER MT ER
n 1,580 1,580Mean daily return -0.102% 0.017%Standard deviation 3.911% 2.041%Holding period return -93.9% -5.4%Compounded annual growth -36.0% -0.9%
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 12
VIX ETP market: PerformancePersonal favorite is VXX.
Recall VXX is highest market cap ETN at $1.8 billion.1/29/09: Launch date. Sold at 100.00.11/08/10: Closed at 11.29 (–88.7%).11/09/10: 1-for-4 reverse split. Closed at 45.39.3/30/12: Close at 16.78 (–63.0%).
VIX ETP market: PerformancePersonal favorite is VXX.
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Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 13
VIX ETP market: PerformanceWhy has short-term index performed so poorly?
“Contango”: VIX futures curve is usually upward sloping.Consider curve on March 19, 2012.
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VIX ETP market: PerformanceWhy has short-term index performed so poorly?
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Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 14
VIX ETP market: DestabilizationLeveraged and inverse products complicate matters.
ETPs must be rebalanced at end of each day.Adjustment to notional amount of futures position to maintain neutral position is
where L=1 (as with traditional ETF), no futures rebalancing.where L<>1, futures rebalancing is required and is always in same direction as index move.
( )21t tNAV L L R +−
VIX ETP market: DestabilizationIllustration: Consider double-leveraged ETN (L=2).Leverage factor 2
Notional Dollar Notional AdjustmentIndex Index at beginning change at end to futures Percent Formula
Day level return NAV of day in value of day hedge adjustment value0 100 100 2001 90 -10% 80 160 -20 180 -20 -11.1% -202 99 10% 96 192 16 176 16 9.1% 16
Notational amount of futures hedge
Amount of rebalancing is huge and in same direction of index move.Trading is inherently destabilizing and leads to front-running.
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 15
VIX ETP market: DestabilizationIllustration: Consider inverse ETN (L=–1).
Leverage factor -1
Notional Dollar Notional AdjustmentIndex Index at beginning change at end to futures Percent Formula
Day level return NAV of day in value of day hedge adjustment value0 100 100 -1001 90 -10% 110 -110 10 -90 -20 -22.2% -202 99 10% 99 -99 -11 -121 22 18.2% 22
Notational amount of futures hedge
Inverse ETNs require even greater rebalancing in same direction of index move.Note rebalancing is in same direction for double-leveraged and inverse ETNs.
VIX ETP market: Destabilization
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Hedging demand Open interest
Trading volatility 5/11/2012
Copyright (c) 2012 by Robert E. Whaley. All rights reserved. 16
VIX ETP market: At what cost?Most active VIX ETPs are not suitable as buy-and-hold investments.
Systematically lose money due to contango trap.Re-hedging demand reinforces steep term structure.
Should not be considered asset class.Are retail customers being harmed by ETPs?
Should SEC allow complex futures trading strategy to be public stock?
Levered and inverse products are inherently destabilizing.