Monthly Archives: March 2012
Investors who followed the price action of TVIX today witnessed a great example of what can happen when using leveraged and inverse ETNs. The TVIX is designed to give an investor twice the daily price movement of the VIX. If you want to place a hedge and think that volatility is going to rise, the TVIX should give you double the action of the VIX and make for a good hedge when IV is rising.
Today the VIX rose and TVIX got crushed. In February, Credit Suisse announced that it was not going to create any more shares of TVIX. As a result TVIX is driven by market forces and can trade at a premium or discount to its indicative value, like the NAV of a closed end fund. The last few days TVIX has been trading at a substantial premium to its NAV. Because Credit Suisse is not creating new shares the algorithm that allows it to track its index, the VIX could not work and the mass selling on very high volume brought the shares down to an all time low. Volume was more than two and a half times its three month average. Today’s fall was almost 30 percent. Yesterday it had closed over 80% above its indicative value at $14.43. Today it closed at $10.20.
When using any leveraged or inverse funds investors need to do their homework and know what they are buying and how to apply them to a trading or investing strategy. Before purchasing a levered or an inverse fund it is critically important to understand the structure of the fund. They have added risks. The funds are designed to move up by twice the amount of an index, or move up if an index declines or move up double or triple the amount an index declines on a daily basis. The key word here is daily. Over longer time periods they will not perform with double leverage. Due to what’s known as ‘roll costs’ and after factoring in how daily market volatility works, the funds may not perform well over longer time periods.
You can own a leveraged index fund, watch the index gain over a long time period and see the leveraged fund decline in value. Here’s a real world example as reported by the SEC, the Securities Exchange Commission. Between December 1st, 2008 and April 30th, 2009 a certain index gained 2%. A leveraged fund that delivered twice the daily performance fell by 6%. During the same time frame an ETF seeking to deliver three times the daily performance of an index fell by 53%, while the underlying index gained about 8%.
Before using a leveraged or inverse fund, check past price action to see if it is performing as it should relative to its index. Check the fundamentals of the issuer for changes to its credit rating or if they have suspended issuing any new shares.
ETNs can be great tools for portfolio management, but one must understand the risks.