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.