Is UVXY Benefiting From TVIX’s Woes?

February 24, 2012

TVIX’s halted creations provide a fresh glimpse at the ETN vs. ETF debate.

Trading volume in the ProShares Ultra VIX Short-Term Futures ETF (NYSEArca: UVXY) shot sharply upward on Thursday in the wake of Credit Suisse’s announcement yesterday that it was halting creations in a competing product, the VelocityShares Daily 2X VIX Short-Term ETN (NYSEArca: TVIX).

It’s just possible that ETF investors keen on taking a long position in VIX volatility futures are segueing their exposure to the ProShares ETF from the VelocityShares ETN, according to a number of ETF industry sources. The say putative shortcomings of futures-based ETFs, such as relatively complicated tax treatment, seem irrelevant at a time when the market for volatility products is so hot.

“It sounds rudimentary, but yes, people are probably swapping out of TVIX and into UVXY,” said Paul Weisbruch, an ETF trader at King of Prussia, Pa.-based Street One Financial. Weisbruch said the halting of creations came at a time of heightened interest in futures contracts linked to the CBOE Volatility Index, or VIX. He said VIX contract prices look cheap at a time of continuing economic uncertainty.

Almost 5 million shares of UVXY changed hands today, which compares to average daily volume of around 1 million shares in the past 30 days as the VIX market has heated up, according to data from Bloomberg. Average daily volume in past three months has been just over 610,000.

The trading-volume spike for UVXY has coincided with a big rise in assets under management for UVXY—precisely the reason that Credit Suisse, the issuing bank behind the VelocityShares ETN “TVIX,” decided to temporarily halt creations. Credit Suisse said the ETN’s assets had broken through “internal limits,” suggesting its risk-control desk wasn’t fully comfortable with how quickly it was ramping up complex hedges.

TVIX’s assets have nearly quadrupled this year to almost $650 million, while UVXY’s are also up by nearly a factor of four to $26 million, according to data compiled by IndexUniverse. The interest in VIX-related ETPs also extends to single exposure ETNs, such as the single-exposure iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX), whose assets are up 45 percent to $1.15 billion this year.

Double-Exposure ‘Octane’

All this interest in VIX-related ETPs comes during a period that the stock market looks relatively sedate and almost predictable.

The S&P 500 Index is up nearly 9 percent this year, and near-term VIX futures are trading below $20, in part because of the highest short interest in short-term VIX futures since 2007 before the market crashed, Street One’s Weisbruch said in a telephone interview.

To put that $20 price level in perspective, short-term VIX futures were nearly $50 last summer around the time that S&P downgraded U.S. debt, and were around $80 when the stock market went into free fall in September 2008.

“Some people might want to take the other side of that short interest, and put as much octane into it as possible,” Weisbruch said, referring to double-exposure VIX-related exchange-traded products such as TVIX and UVXY that would pump up returns should Greece’s debt problems or some other big event shock the market out of its seemingly ‘what-me-care’ state just now.

So, with entry into TVIX now all-but restricted, and interest in VIX products strong, UVXY’s popularity appears to be booming.

“The difference—and I can just hear people at ProShares talking about it—is that UVXY is an ETF,” said Weisbruch, noting the simplicity of the ETF structure shines at moments like these, and liabilities melt away.

Problems? What Problems?

Yes, UVXY will have tracking error that an ETN like TVIX won’t have as portfolio managers run up against the friction of buying and selling real contracts in the futures market, creating a drag on returns.

And yes, come tax time, futures-based ETFs are taxed every year, whether holdings are sold or not. Currently 60 percent of any futures gains are taxed at the long-term capital gains rate of 15 percent and the remaining 40 percent at the investor’s ordinary tax rate. All this is covered in a separate in a special tax form, called a “K-1” which many investors regard as an extra inconvenience to deal with.


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