So, you think you know about volatility hedges?

Today I was reading an article about the bizarre trading pattern in TVIX — the double-levered long volatility exchange traded note (ETN).  That’s kind of a mouthful, but it basically boils down to a trade-able security that is meant to appreciate in the short-term as stock market volatility increases.  The oddity today was that 1) the stock market posted a 79 point loss, 2) the volatility index was up nearly 3%, and 3) TVIX fell by 29%!

The inexplicably backward move in TVIX occurred on nearly 30 million shares traded.  That’s roughly 3X the average daily volume.  This post, however, is not about explaining how you can lose money while holding volatility on a day that volatility goes up.  That conversation might be fodder for another post, or we can discuss it in the “Comments” section.

Rather, the bizarre activity led me to look at TVIX’s Pricing Supplement (Prospectus).  More specifically, I paged down to the “Risk Factors” section to see if it could provide any insight.  Three pages into the description of risks, I came across this gem:

“The ETN’s are only suitable for a very short investment horizon.  The relationship between the level of the VIX index and the underlying futures on the VIX Index will begin to break down as the length of an investor’s holding period increases, even within the course of a single Index Business Day.  The relationship between the level of the applicable underlying Index and the Closing Indicative Value and Intraday Indicative Value of the ETN’s will also begin to break down as the length of an investor’s holding period increases.  The ETN’s are not long term substitutes for long or short positions in the futures underlying the VIX Index.  Further, over a longer holding period the applicable underlying Index is more likely to experience a dramatic price movement that may result in the Intraday Indicative Value becoming equal to or less than twenty percent (20%) of the prior day’s Closing Indicative Value.  Upon such an event, your ETN’s would be subject to acceleration and you will likely lose all or a substantial portion of your investment.  The long term expected value of your ETNs is zero.  If you hold your ETNs as a long term investment, it is likely that you will lose all or a substantial portion of your investment.”

The emphasis on the last sentence was courtesy of Credit Suisse, not me.

So, let me get this straight…  if I hold the position for only a day, a bunch of things can happen that may make my holding go to zero.  If I hold the position longer term, it is likely that my investment will go to zero.

And I’d only have to pay 1.65% in expense ratio for the privilege!

Now I would certainly never make investment recommendations on this blog.  This is for informative/entertainment purposes only.  In that spirit, here is the link to the Prospectus if you think I’m joking.

A wild wrap-up to a wild week

Yesterday’s market action, while gut-wrenching in its relentlessly downward slide, was more or less orderly.  The open was a little abrupt, as was the close, but on the whole the meltdown was fairly consistent.

Today was a different animal all together.  This was the kind of day that takes out sell-stops at exactly the wrong time, squeezes out shorts at exactly the wrong time, and punishes short-term momentum players.  The graph that follows illustrates the magnitude of the swings occurring intra-day.


Most of the swings were linked in their timing to the news flow of the day.  The 1.5% rally at the open was linked to this mornings rosier jobs numbers and a decline in the supposed unemployment rate to 9.1% (I’ll stay tuned for the revisions before buying into either number).  The rally was short-lived, however, as continuing bad news from Europe drove the market down 3.6% in 2 hours and 15 minutes.  Then, exactly at noon Eastern, the ECB finally announced their willingness to buy Italian and Spanish bonds (after looking rather feckless for the last few weeks).  When the program is initiated, it will be Europe’s version of QE.  Q€1, if you will.  That announcement sent the Dow higher by 3.7% in 53 minutes.  As the market bounced off its high for the day, it immediately retraced, giving up 1.2% in a scant 16 minutes and 48 seconds.

But wait… that isn’t right…  In the following 46 minutes the Dow bounced back up to its daily high.  Then, traders (realizing that being long over the weekend might not be the brightest idea) took the market down 1.8% between 2pm and 3pm.

As the closing bell approached, the markets made a run — attempting to push the S&P 500 above the psychologically (and technically) important 1200 level.  This pushed the market higher by 1.1% before finally tailing off with the S&P failing to reach its goal (closing at 1199.36).

While I’m no a conspiracy theorist, I can’t help but wonder if the robots (HFT traders) were not firmly in control today; causing such ludicrous volatility.  During the day, I pulled up some heavily traded momentum securities on my trading screen and noted large and equal-sized bids and asks being posted and immediately pulled off without an execution.  One security in particular, VXX (the volatility ETN) exhibited this pattern with alarming regularity.

As I often do when I feel like I might need to break out my tinfoil hat, I checked out the ZeroHedge blog to see if they had any comments regarding High Frequency Trading today .  ZeroHedge often keeps up with Nanex’s information on quote stuffing and other robotic evils.  Sure enough, ZeroHedge had a Nanex-linked blog entry, posted at 3:11 pm, with an illustrated graphic of the quote stuffing that had been going on all day.  And they say robots don’t leave fingerprints…

Yesterday, on CNBC, Art Cashin attributed the market’s major losses to HFT traders kicking in after a “head and shoulders” pattern on the S&P 500 was breached.

I know I’ve beaten the HFT drum more than once on this blog.  In fact, when we first started blogging, I was accused of running an anti-HFT blog!  But the truth remains that these algorithms contribute to freakish volatility, lead to little pleasantries like the Flash Crash, distort the true price discovery mechanism of the markets, create a false illusion of liquidity and market depth, and violate the principals (and the rules) of the markets by executing only a small fraction of the trades they put out on the bids and asks.

Maybe some day the regulators will pay attention to this, rather than focusing on “important” things like retooling how investment firms’ Form ADV Part II look (do you even know what that is, or have you ever read one?) or auditing firms for improper use of social media (gulp!).

With that, I’ll conclude my Friday Rant and wish you all a great weekend!