A little over four years since 2018’s Volmageddon, and 2 years after TVIX got terminated – two new VIX ETF’s were recently launched – the 1x short VIX exposure SVIX and 2x long VIX exposure UVIX by VelocityShares. What’s different about them, how do they protect against another Feb of 2018 event. We’re going straight to the source(s) to answer those questions and more; chatting up three musketeers of VIX expertise: Stuart Barton CIO of VolatilityShares @VolatilityStu, Jim Carroll of the @Vixologist Twitter handle, and Six Figure Investing blog writer Vance Harwood @6_Figure_Invest. They join us to talk through just what is innovative about this new approach, and why such innovation was necessary.

This all-star trio talks us through the plumbing behind these new VIX products (including their new index construction/design, rebalancing methodology, and VIX vs.VIX futures), why all levered ETFs suffer from Volatility drag, why futures based ETFs suffer from Contango, and what can be done about those two issues, knowing the difference between ETPs, ETNs & ETFs, what’s in store for volatility the rest of the year, and everything else having to do with VIX futures. Plus, we get an interesting insight into their hottest takes!

 

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Check out the complete Transcript from this weeks podcast below:

What’s New about the New -1x/+2x VIX ETFs SVIX and UVIX with Stuart Barton, Jim Carroll and Vance Harwood

 

Jeff Malec  00:07

Welcome to the derivative by our RCM Alternatives, where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world. All right, welcome, everyone. We’ve got the three musketeers of volatility trading here. Is that good? Is that are musketeers respected or or panned? I don’t know. I don’t know. But in in that context, I meant for it to be respectful. We’ve got Vance Harwood of six figure invest Stuart Barton of volatility shares and Jim Carroll of Toronto that say that right, Jim? Yes. To robo advisors, which you told me once again before on the pot, that’s like a shark mashup or something, but it’s, it’s bull and bear in Spanish. Oh, and Baron. Got it. I think I made the same mistake last time asking if it was a sharp. So wanted to get everyone on to talk about the new volatility ETFs that have come out a long time coming. And start with Vance, who had a nice post on Twitter kind of digging into what’s going on here bringing up a lot of interesting pieces of the new products. So Vance, what did you find interesting about these these products? And what can you tell us?

 

Vance Harwood  02:38

Okay, so actually is a bit of foreshadowing in 2012, I was doing a blog post on leveraged ETFs. And in this in the blog, I was working through Apple, if you did a 2x apple and just what would that take. And you know, just trying to understand kind of the next level of details on deleveraging ETS. And the thing that struck me when I was looking at this was when you have leveraged ETFs, let’s say at times too long or minus one inverse is the way they they typically operate at the end of the day, they need to rebalance. So that they performed, you know the correct way the next day. So to x, they rebalance. So next day, they’ll continue to like do twice the percentage move of today’s move, and the minus one, they have to do the same thing. But the thing that really surprised me was that the rebalancing needed to be in the same direction. So you have a short fund and a 2x long fund. And yet at the end of the day, they’re both rebalancing the same direction. So this and that was really non intuitive. But if you think about it a little Same,

 

Jeff Malec  03:56

same direction as their stated goal of a long or short or it’s same direction as

 

Vance Harwood  04:01

each other, they’re both either buying or both selling. Got it. And so for example, if the VX X or VX, if Vi x, y goes up 10% Then a QX is going to want to go up approx the next day about twice that. So if it’s gone up 10% Today, they actually need to add the reach assets. So they track that next day it’s move. On the other hand, the the inverse fund. Since the market was the volatility went up, they’re now overexposed. So they need to reduce their their position but they’re short so the way you reduce the short position is you buy shares. So, you know, this struck me is you know, my background is electrical engineering and this is something called positive feedback where the market goes up 10% And then you at the end of the day you add on you Buy more. So that’s going to tend to drive it up more. So at that point, I thought, well, that’s that’s a weakness. And if that if that market is small, then you could have kind of a chain reaction. And then fast forward to 2018 with fifth of Feb 2018, this, this wasn’t a small market. This was actually a big market with the VIX futures and maybe $10 billion in open interest. But you had huge volatility funds with XIV SV X, Y, UV x, y. And, and so all those assets after a huge, you know, 100% move, and the VIX, then we then there were billions of dollars at the end of the day, that had to all go in the same direction. So and, you know, the market, just the liquidity dried up at that point, and we had this last 15 minutes was a disaster. From a liquidity standpoint,

 

Jeff Malec  06:02

right? The tail wagging the proverbial dog. Right, what s&p was only down 4% or something.

 

Vance Harwood  06:07

Yeah, that was a, you know, significant, but not unusual at all from the magnitude there. So I think, I think so going forward thinking about coming again, with a 2x long and a minus one inverse? You know, that’s a huge issue is how do you avoid doing that? Again, let’s let’s let’s not make the same mistake again. And so I think the construction of that sticks, and, and UX is really designed to avoid that sort of scenario.

 

Jeff Malec  06:40

And let’s dive into that construction a little bit. Just Are you available to talk about that construction should pass it to Jim?

 

Stuart Barton  06:49

I think I think I can say, say a little, you know, for the benefit of listeners, of course, issuers are under some restrictions on what they what they can say, from a compliance perspective. So first of all, I’d say these products are not for everyone. And I recommend everyone to go and read the read the prospectus, which is obviously available publicly on our website and elsewhere. So with that said, Yeah, I absolutely agree with what Ben said, there’s, there’s been an interest in leveraged and inverse products. And I think when some of the early products were designed, they they didn’t have the hindsight that we have today. And what that meant is we’re sort of in a better position to look at what the potential problems are, and improve upon or at least do what we can to try and try and let them suffer from from fewer problems. In our case, we decided to go back to the drawing board. So all previous vix products have tracked very similar indexes, the SPX SP. And it’s kind of similar indexes, effectively track the performance of portfolio of vix futures, month one and month two, from settlement on day one to settlement and day two, and day two to day three, and so on. So you’ve got the settlement, a settlement performance, which if one wants an elegant solution, that, of course, is a very elegant one, the settlement is published, it’s very, it’s very easy to access, and so on. The problems with that arise when one gets involved in the need to rebalance and the the leverage and inverse space, so probably wouldn’t surprise you that the first product that obviously tried to track this index was the VXX from Barclays Etn. And of course, that that product not leveraged or inverse, so it doesn’t have a rebalance need. So it doesn’t, it doesn’t necessarily suffer from the same problem. So going from going from a settlement to a settlement is simpler, because there’s no need for this rebalance. As soon as you get into the rebalance needs, a settlement isn’t necessarily the best target for a refund to try and hit. What it does is it means the portfolio manager has to try and get as close to or replicate that settlement, which can be difficult. In the VIX markets, the market for trading and settlement was established and became quite liquid, the trade of sentimental tears market. And that market as a sort of a separate market to the sort of cash futures market for vix grew considerably as the leverage and inverse products grew. Now, that was sort of a solution to the problem. i The managers were able to hit that that that settlement relatively easily by putting orders into a trade settlement market and Every day having getting effectively getting settlement or very close to it. The problem with it is it puts an enormous reliance on one market that sort of prints and executes all at the end of the day. And if anything should go wrong with that market it it leaves everybody in a very weird situation whereby they may or may not be able to rebalance the funds that they thought they were going to rebound. So I think February 5 is, there’s a lot of speculation on on how it came about. But I think what we do know, is something went wrong in that tears market, at a Tazz market that had grown outside of the VIX futures, cash market, a market that people had come to rely on, and something went wrong. And as soon as something went wrong, we sort of noticed how anybody trying to rebalance this sort of scale of products in such a short time can cause a mask or a market disruption can can can be the outcome. So we’ve been lucky enough to look at that history and say, well, let’s go back to the drawing board. Let’s let’s redesign an index. Let’s go right back to actually designing an index that might be more sustainably trackable by leveraging inverse products. And that’s what we did together with the CBOE. We spent at least a year working with them on the short vowel and the later the long gold indexes. And those those indexes do do a few things differently. But perhaps the most important one is they measure their performance from a T whap. Of the last 15 minutes of trading in in the underlying and vix futures must get to the T whap. The following day. And, you know, some may say there’s a very subtle difference, it’s 15 minutes of trading versus, you know, settlement price. But But what it does is it moves this need to rebalance from a single moment in time to a period of time. And, you know, I think we believe in and other market participants, we’ve spoken to believe that that’s a significant improvement if one as an index, if one was was planning to track it with them or with a with a fund.

 

Jeff Malec  12:22

And just to clear that up and whoever wants to jump in so that the products have instead of whatever the VIX closes out on today, Tuesday. It’s whatever the 15 Minute. T whap. Is a vix closing prices on today.

 

Stuart Barton  12:39

Yeah, that would I mean, maybe, maybe, maybe Jim or advance VA will tell you more. But I mean, the reality that that’s, that’s sort of what it comes

 

Vance Harwood  12:48

down to whether there is a mix with the Taz also structured into the index. So it’s actually half the T whap. And half the Taz clothes

 

Jeff Malec  12:58

and the Taz for lack of a better term right back in the old days, we’d be watching CNBC, and they’re waiting for some stock to open because the specialists have to match the flow, right the buys and the sells before they give an opening price. Essentially, ties is the reverse of that of like, Hey, we got to match all the buys and sells at the settlement.

 

 

 

Vance Harwood  13:17

No, it’s not a it’s not an auction is my understanding, it’s more of the sense of during the day, you can put in Taz orders that I want to buy or sell a certain amount of futures at the at the settlement price. And, and there’s there’s a sweetener possibility there. If the market is going one way or another, you can say well, I’ll pay the settlement price plus, you know, half a basis point or something like that. So so that accumulates during the day and you actually get a confirmation on that, you know, if it’s gonna go in, you get a confirmation. So that’s an order that’s in and then you know, whatever. The CFE has a settlement process that ends up with a number and that’s typically quite close to the last trade, unless there’s some sort of abnormally abnormal, normal normality. That’s where the test comes from.

 

Stuart Barton  14:17

If I just add one thing that I think because a lot of people misunderstand that TASMAC I think it’s it’s uncommon, I think for for non professional investors to deal in it, it’s typically dominated by the institution’s the key difference between it and for instance, a market on players order that you know, we have these inequity, you can give your broker market and close order and you can execute it close. The difference here is this is a parallel book. This is this is an order book that runs in parallel to the VIX futures cash market. So if I put an order in and say I’d like to buy the settlement and somebody would be making a market in settlement, maybe it’s minus one and plus one basis points above and below settlement and I Want to buy 50 futures at settlement, I can put that into them into it, I can pay a basis point over settlement, my execution, and I am done at the time that I have taken that market that I’ve lifted that offer. So unlike a market to close, you can phone your broker back 10 minutes later to go actually take me out of the club, I don’t No need to do that order anymore. I am done. If I want to go back the other way, I have put another order in now to sell the settlement and put my futures in a bid. So it is a parallel book that trades together with the cash market.

 

Jeff Malec  15:34

But to me, it seems like you can break more, right? If I if there’s 5 billion to buy on the settlement on tears and zero to sell, right? Doesn’t it get in theory could get out of whack that parallel book could be way out of whack of what the futures are doing?

 

Stuart Barton  15:50

Well, I think Vance had some excellent comments, because I think that’s what was the there was a what happened was there was a market there was like a markets at market down limits on the on the tears events, I’m sure.

 

Vance Harwood  16:02

So at that point in time, the CBO we had a point one point limit on how much the offset how much sweetener you could put in on the Taz order. And my understanding is the second or third hand but well before the end of the day the market kind of seized up because no one was interested in taking the other side of the of the market. And I think these are most likely buys because the the market was the volatility was spiking up. So the Taz market basically grind to a halt. There was no you know, parties on the other side that were interested in, in negotiating on the Taz order,

 

 

Jeff Malec  16:48

and then never flipped. Okay, I gotta still get it done. So I’m going to do it mark.

 

Vance Harwood  16:53

Again, second or third hand, you know, pro shares, wasn’t able to, you know, this is speculation, but the speculation is pro shares, we’re typically using the Tazz market and when that test market goes away, then you’re left with the situation of okay, now I have to go into the open market. And, you know, while it’s spiking up or aftermarket is a possibility, and you know, they they ended up paying a lot less to do the rebalance than they would have if it had had used the TAs market. So for their shareholders, it ended up being a good thing, but it was a chaotic situation. So just one final notice since then the CBO is increased that from point one to point five is how much of that offset so they’ve increased that offset by a factor of five. And they’ve they’ve also Well, they’ve moved to 4pm instead of 415, which I think is good because now it’s aligned with the equity market. And the other thing CBOE has done is they’ve, they’ve added a volume weighted average price calculation the last 30 seconds before close. And so that so those were three things at all that I think have all made the VIX close and settlement more robust from where it was in 2018.

 

Jim Carroll  18:16

Just to emphasize something that came up earlier, vix versus vix futures, because we’re not talking about the VIX here. We’re talking about vix futures. And in the case of all of these products, that is some blend of typically the front month and the second month vix futures, you know, depending on where we are in the expiration cycle, and, you know, in the in the day, and I guess we do still have vix M. There, there are products that trade the further out vix futures, but again at eight the VIX, these are vix futures. That may or may not reflect whatever’s happened to the VIX on a given day.

 

Jeff Malec  19:10

Well, because to get into that you can’t trade the VIX itself, right? That’s correct. So you could approximate it but you how many options would you have to buy or hold or?

 

Jim Carroll  19:22

I gave up I gave up even trying to think about that a long time ago because people with a lot more brainpower than I have concluded that it was a fool’s errand to try to replicate the VIX in any kind of trading way.

 

Jeff Malec  19:37

And we when we mentioned the cash fix earlier, were we talking about like OE X options and the actual price of certain options or what were you talking about cash fix.

 

Jim Carroll  19:47

I think typically, when people were referring to catch vix or spot VIX, they’re referring to the quoted vix index. You know, and so no, it’s it’s not cash in the sense that you have as we as as VanSant store referred to a cash market for vix futures versus a Taz market for vix futures. If somebody says cash vix to me, I’m I’m I’m assuming they’re talking about a spot vix quotation. God has done the calculation using a broad strip of s&p 500 index options

 

Jeff Malec  20:30

leave you with the floor here. Jim. What are your thoughts on right some of the articles of like, hey, for years after volume again and new VIX, ETFs levered VIX, ETFs there’s kind of painted with a negative brush. But for you, and what you do in your work like these are invaluable products. So talk a little bit about who what type of investors can be using these and why it’s not necessarily an evil thing.

 

Jim Carroll  20:56

A weapon of mass destruction exactly like Warren Buffett describes the derivatives that are bound in his portfolio. Please stay away, don’t don’t use them. They’re all for me. Well, and I think, going back to volume again, going back to Feb. 15. Actually, let’s go back a little further because I think the rub really began when people discovered the short vol products XIV grew to be the biggest SPX Why was the alternative? And in 2016 2017, when the markets were relatively calm, you know, basically upward sloping. And the vix index volatility, however, you want to measure it, whether it’s implied volatility using the vix index, historical volatility, all forms of volatility, we’re just grinding down to historically low levels. And so being short, the VIX futures, when that vix term structure is in contango, and we can explain that. But, you know, basically, it was a one way trade. And in 19, in in 2017, if my memory serves, XIV was up, let’s round it 90% Something like there might even be might have might have been more than that. From from start to finish. And, and so, you know, when something like that happens, people pick up on it, and people were piling into this Sure thing, short volatility trade. You know, there’s a stock called XIV,

 

Jeff Malec  22:44

right? We had the Wall Street Journal piece on the target manager who’d made a couple million bucks off.

 

Jim Carroll  22:51

Exactly. And

 

Jeff Malec  22:54

so how does that work? Like, I can’t remember the name of them. Now, there was the ultra long natural gas ETF and the ultra short natural gas ETF, you guys and D gas, and if you put a chart of them, they both went basically down to zero. So it doesn’t make sense. It should be opposite. But in the end, the VIX and inverse vix they don’t both erode to zero because of rebounds. He explained balancing

 

Jim Carroll  23:20

and because big N because in, in round numbers 80% of the time the VIX term structure is in contango. So if you, you know, if you just sit short on that term structure, you’re going to make money over time. The challenges are twofold. You can get the periodic circumstance where the market has a hiccup and the entire term structure lifts. And so, you know, it’s still in contango, but it’s in contango two or three or four or five points higher, and you’ve had a bad day. If you can recognize that it’s just a bad day and the term structure remains in contango, you might want to keep your short position. Maybe you’ve got some hedging around it. But it’s when that term structure flips from contango or backwardation, which is one of the things that happened in early February 2018. Then, then that’s going to be more than just a bad day, if you are short volatility. And, you know, that’s the bottom line is that I you know, if if XIV was $2 billion of AUM going into February 5 2018. I would wager that 1.8 billion of that did not understand the difference between contango and backwardation in the VIX term structure and what the real risks of being short volatility are. And as a result, you know, We’ve all collected stories of people who lost huge sums of money in that set of circumstances, but the reality is, this is a tool for investors who understand how this all works, and want to express a view about whether it’s a good time to be short volatility, or long volatility. And whether, you know, you take Chris Cole’s adage that, you know, there’s only one asset class and it’s volatility. You know, I, I got involved in this because it struck me that this was a way to get tactical exposure to in a very different way. You know, I was used to taking tactical exposure through exchange traded funds that represented different asset classes, different geographies, you know, fixed income, equities, commodities, etc. And, and when I began my own investigation of these volatility products back in 2014, and 2015, it was just a little light bulb kind of went off and said, you know, this is another way to express a tactical view on where the world’s going. And as a result, you know, I was a big user of XIV in 2016 2017. Got out in the middle of January of 2018, because you know, that the, the system that I use said, it’s not safe anymore. But I think unless you have some way of protecting yourself, and that can be there tactically, buying and selling these things, or hedging your exposure in some fashion, you know, you could be short volatility over here and have some, you know, vix call options to protect you, if all hell breaks loose as a way to hedge your portfolio, there are a bunch of different ways to do it. And again, there are people much smarter than I am out there playing in this field, but there are use cases for this in the right hands. It’s lucky you’ve got leveraged ETFs across the landscape, triple this and quadruple inverse that. And they’re really no different. No, no less safe than, than this and I think the great thing from my perspective that Stuart and his team have done is they’ve taken as, as he said, the benefit of hindsight to reengineer these products and make them safer than

 

Jeff Malec  27:59

I think of TLT right now, right? Like, safe product funds with an inflation hedge, right? It’s down 30% If you had a triple levered TLT, you’d be down 90% i Yeah,

 

Jim Carroll  28:11

go go look, there is a an ETF. Zro z. That is, you know, long dated zeros.

 

Jeff Malec  28:20

Yeah. Yeah. Zero, nice ticker.

 

Jim Carroll  28:24

So much for protecting your portfolio with a fixed income sleeve. Right.

 

Jeff Malec  28:29

And talk a little bit of I know some of the firm’s make the disclosures make you have to have the disclosure right of this isn’t for long term holding. This is as new use the word tactical. So on the long side, for sure. It seems like maybe like you shouldn’t just buy and hold this thing for three years, it’s going to erode, right? Because of the VIX. reverting down to the cash, which we talked about price every month. On the short side, though, we could argue that right is that we basically saying the contango premium is higher than the negative carry of the rebalance.

 

Vance Harwood  29:07

But I think the situation there is you still have dramatic drawdown so yeah, yeah. So when you have the volatility spike, then volatility takes off. And, and you get I think my data said there have been two 90% drawdown since 2005. So, you know, buy and hold, you know, if you hold it long enough, but not many people are willing to tolerate a 90% drawdown. So I think, you know, best practices to have some strategy that mitigates that either an exit strategy is dimensioned, or some sort of option strategy to limit your downside.

 

Jeff Malec  29:48

Yeah, but even when I’m trying to get it even without the spikes, right back to that natural gas long and inverse, right, they both went to zero just because of the rebounds cost. Right. So does anyone have data on what the rebalanced, Costas, whether it’s any leverage ETF, not necessarily.

 

Vance Harwood  30:05

Yeah, the the, the aspect of this the vault, there’s there’s two things as Jim mentioned, there’s the contango, which is very hard on the long funds and good for the short the inverse funds. The other aspect is something called volatility drag that, that all leveraged funds suffer from Yeah, but the formula for that is really nonlinear. So for example, a 2x long and a 1x. Short, the volatility drag per period is the volatility squared. So that’s, so if volatility doubles, then you know, you’ve got a 4x increase in volatility. If you’re a 3x, then that goes to three times the volatility squared. So even though you’ve just gone from a to x to 3x, the volatility drag tripled. So that’s why you see the 3x funds, both the long and the short going to zero is because any sort of contango gains or any sort of, you know, beta in the market gets swamped out by the volatility.

 

Jeff Malec  31:07

Got that? You went? That was fantastic.

 

Jim Carroll  31:12

Well, I think the other thing that that has caused people well, and look, look at the trading volumes in the in the world call the the 1.0, volatility etps uvxy s Fixi, Vixy, Vixie. The trading volumes are still quite large. So there are obviously people out there using these things every single day. Now, how many of those are sophisticated hedge fund the kind of people versus retail investors? Good question. I don’t have the answers. But one of the reasons that people don’t like these products and don’t like this space, is because as as you were suggesting, if you’re long these products, you’re quote unquote, bleeding to death, waiting for a payoff. Right. And if you’re short, these products, you’re picking up pennies in front of the steamroller. I mean, that’s a freight

 

Jeff Malec  32:16

train. But yeah.

 

Jim Carroll  32:21

Yeah, you know, well, and you can certainly hear a freight train coming. And if you don’t get out of the way, then you probably deserve to be run over. But you know, that’s my bias. Because I do believe that, you know, these products can be safely deployed in the hands of somebody who understands how they work, how the VIX complex works, and how to mitigate what are structural biases. There’s a structural bias for the short volatility products to go higher. As the market goes higher, there’s a structural bias for the long volatility products to bleed and and only have occasional payoffs. And therefore, if you’re looking for something to just stick in your portfolio and forget about don’t use these. Yeah, because you’ll wake up one day and well, yeah, you’ll do what the state of California did with their alleged universa position. Yeah, they exited before March 2020. Because it was bleeding too much.

 

Jeff Malec  33:33

Yeah, and I’ll take it as ever. I don’t use any ETFs that use futures that have contango and backwardation, right, you’re just gonna, you’re gonna get chewed up

 

Jim Carroll  33:44

over what you’re doing, or you need to have an advisor who knows what he or she is doing.

 

Jeff Malec  33:54

And let’s talk for a second Stuart on these are ETFs right, so I’ll just quick definitions, we’ve thrown out etps Exchange Traded products, ETFs, exchange traded notes, ETFs, exchange traded funds, all somewhat interchangeable, but important differences. So XIV was an Etn. Right in in the prospectus. They had to basically blow it out at what was it down 85% 2595 To save the firm, right, like they have to have the positions to back the note, it was a note drawn on the credit worthiness of the issuer.

 

Vance Harwood  34:29

So they had the option to terminate and they if it went down a certain amount, I think 80% And in the case of XIV and may they chose to do that they could have they could have kept running but they chose to terminate. And then

 

Stuart Barton  34:43

it’s a good point to bring up the I think that the market is a little confused about the difference between et NS and ETFs. And you know, sometimes I you know, I see professionals even getting it wrong when they when they write in the press so The key difference, obviously one is a fun one is a note, a note is much more like a piece of piece of credit. And a fund is like any fund that we weave, we know. And the real difference for the big space is, one is sort of a promise to pay a pay off by a bank, in this case, Credit Suisse, Barclays with the main issues of the notes, and managers. Whereas ETFs actually hold a hold assets, they hold cash, and they own futures in the normal shorts, but they actually actually hold what they’re trying to track. And the difference there, I guess is, it becomes important when you get to the fringes of operations. For instance, if we went into a terrible banking crisis, you know, volatility might spike and go to two incredible highs. And you might think, Well, my, my notes issued by a bank is going to my big slick note is going to make me a great deal of money. Well, it is possible in that situation that it might go to zero might go down, because of the credit worthiness of the bank that issued it may may, may be impaired. Whereas, you know, in a fund, the actual assets that you’ve invested in as investors sit in the fund. That’s one difference. The other one, and I think it’s important to remember that most of the horror stories we’ve heard about vix link products have unfortunately been in the Etn space. And it’s sort of because the Etn is a is a cleverly devised workaround in order to issue something rather than a fund that we all kind of perhaps better understand. And one of those facets that failed the Etn product structure in the big space, is this idea that if you if you issue a note that has a certain payoff, it’s down to the bank and its traders to hedge that and they can hedge it however they wish. But of course, it’s in their interest to either have to absolutely hit the hedge spot or not make or lose $1 $1 more. But it’s actually slightly in their interest in beats that benchmark. So it is it is, unlike a fund where if the if the trading portfolio management team did a little better on a day they beat the index benchmark, the gains in that situation go to the fund holders that didn’t you know, did a little better than or worse, but that economic impact sits with the with the fund holders, with a note that’s different. And it puts note issuers into a strange conflict of interest, where it’s in their interest to either nail the benchmark or improve on it. And of course, if there’s if there’s potential profit to be made, it’s likely one would err on that side rather than err on the side of loss. So, you know, I think I think things like that are, are starting to become more known. And I think it’s starting to mean that notes are being called the operation of the trading activity behind notes and starting to be questioned. But vix products have been very much at the center of that because there’s been so much activity and because some of those notes were so large,

 

Jeff Malec  38:13

well imagine the rate you’re looking, I can’t remember what you said, Jim, but 2017, right, of the short vix trade, and you’re the bank that has to give that exposure. Someone for sure is in the bank saying, hey, if we just book this ourselves, right, we made an extra billion dollars last year. Real money. So

 

Jim Carroll  38:31

let’s go back, go back to 2020. Right? Where if you were fortunate enough to think this. This pandemic thing might cause a little panic in the markets and you bought T vix in February of 2020. And it went up 25 times to its peak in March. And your Credit Suisse, because T VIX is a note on your balance sheet. And suddenly it’s an $8 billion dollar

 

Jeff Malec  39:11

decline on the bank all of a sudden.

 

Jim Carroll  39:14

And, and, and gee, what happens if this thing you know, keeps going, Yeah, keeps going or hits a bump or, you know, whatever. And so T vix effectively has disappeared. I mean, it still exists. But credits we said, Yeah, we’re gonna delist this.

 

Jeff Malec  39:38

Yeah, well, well. We had a nice pod with you Jim saying T vix gets terminated. So we’ll put that in the show notes. But I feel like investors feel it’s their God given right to always be able to trade that ETF, right. And issuers are like, Hey, we have to actually put on trades and do that the investors kind of ignore the mechanics and just say it’s my right to have this And what we just saw this year right at Barclays said, which nobody knew at first what was going on, but we’re halting creations and redemptions turned out because they forgot to fill out the right paperwork or whatnot. But right like people were going nuts. What do you mean yours halting I need to do more of this. So the ETF sort of solves that. Right? You get rid of the Etn problems, but what other issues does the ETF bring, besides having taken two years to get through the SEC?

 

Vance Harwood  40:29

One other one other advantage of s fix and Uvex. And I think this is unprecedented is there’s also an agreement to not have not trade more than 10% of the VIX future volume. I think it’s a 15 minute period, is that correct? Store?

 

Stuart Barton  40:47

Yeah. So we’ve committed to stay below Tim, since the volume during any rebounds, period. So to extend that rebounds, period, yeah.

 

Vance Harwood  40:56

So what this effectively does is prioritize the stability of the market and the impact that these funds have on the market, instead of prioritizing tracking the index. So for example, Credit Suisse really didn’t have a choice, you know, legally there, they were tied to the index. And, you know, whatever the index did, they pretty much had to follow, whereas pro shares as an ETF, they certainly seek to follow the index, but when push comes to shove, they, they don’t have to follow that. And it’s really about their assets, not the index. So you know, as when you get into these extreme situations, that’s a big difference between the ETFs and the ETFs.

 

Jeff Malec  41:44

But as an investor, how do I think about that, okay, I’m not gonna get the PAP that I think I’m gonna get, or I’m gonna get 90% of it, or 98% of it are?

 

Vance Harwood  41:53

Well, in the case of all mageddon Both the long and the short fund did better. Because they because brochures didn’t track the index. So that’s where this volatility drag kicked in big time, the volatility was so huge that the single day volatility drag was, you know, a huge impact on XIV.

 

Stuart Barton  42:15

I think, to add to what Vance is saying, I think it’s important to understand that and then started with his, with this point that leverage inverse products that have to rebalance frequently rebalance in same direction, but more importantly, they can be rebalancing against the interests of the holders. Now, you know, for instance, in that example, of XIV, the hedging bank would have been buying futures and rising futures market, which no doubt would, of course, some further rise in the value of those futures, which lower the value of the note. So it gets itself into a potential feedback loop. Now, if you are legally obliged to pay the pay off of an index, and you are sitting with the need to hedge that, because you don’t want to make a loss internally, you get this, as I, as I pointed out this, you’ve got different motivations here, you’ve got, well, I really do need to need to cover this, but I might cover it. And it’s not in the interest of my shareholders to cover it or leave the unit holders to cover it. And that’s it’s a weird situation to be in, I would have hated to have been in that situation on the day with the banks we’re in with within notes, but you know, very strange one to be in and as as well, as pointed out by not continuing to rebalance, which I think is what proche is, did they did it, you know, go against the interests of the shareholders. And in the end, it was in their favor, because by pushing further would have just pushed the product, you know, further against them and rebalance would have been more expensive.

 

Jeff Malec  43:56

And talk through that from one second. So if I had $10 million in ETF long, ETF, vix rises 10% We can talk later and we’re not supposed to quote vix and percent but

 

Jim Carroll  44:13

the VIX futures rise 10%

 

Jeff Malec  44:15

Yeah, the VIX futures rise 10%. Now I’ve got what did I say now I’ve got 11 million and exposure or so I have to buy that extra 1 million, but did my futures in increase or I still only have a 10 million bass? So explain how those mechanics work from?

 

Stuart Barton  44:34

Well, I mean, simply put it in the case of, I think fifth fifth wheel, which I think you’re

 

Jeff Malec  44:41

just any any old day when I have to rebalance? Yeah, well,

 

Jim Carroll  44:45

if you’ve got a 1x If you’ve got a if you’ve got a 1x long, then you’re right, your portfolio is just tracking the futures but if you’ve got a 2x long, then then you do have to go allowed by more to maintain your 2x exposure. I think

 

Stuart Barton  45:06

that the important point yeah, that’s about the tracking is if your activity pushes the underlying against the interests of the Shaolin, or in the savings in the VIX on Feb. Fifth pushed the VIX futures higher, you’re in the situation where the short product buys back to many of its vix futures. So adversely affects it in that way, if you get a recovery the next day, which we did, but in the, in the long, the two times products that are on that day, the T vix effectively leveraged up more highly than that it needed in Baltimore futures. And more than indeed it should more than possibly it would have needed if there wasn’t so much buying activity. And then when we got the recovery, the next morning, it lost more value than then than it needed to. So to Dan’s point is sort of saying, well, both products long and short, effectively got harmed by by what happened on Fifth fifth, at least if you measure over a period of time longer than the one day because by Feb, six, sevens, you know, both products have been adversely affected by that activity.

 

Jeff Malec  46:14

Right? The issues you didn’t didn’t know, a priori what was going to happen on Feb six, Feb seven. And let’s, let’s talk about the good side of volatility drag, right like so if I’m using the long product, and I can rebalance into my beta into my stocks which have since come out, right, that’s the whole idea behind tactical using the product right, or even into the short ball. So I think we spend a lot of time on the on the negative who, who wants to tell me some of the positives of the product?

 

Jim Carroll  46:48

Well, so I think what you’re, what you’re getting at is, is if you view this as a piece of a portfolio, giving you long volatility, let’s go back. And because I have to remind people of this all the time, I say, Well, you know, how’s your portfolio position from a volatility perspective? Well, what do you mean, it’s, it has no bearing on, I say, Well, do you own stocks? Well, yeah, of course, I own stocks, well, then you’re short volatility. What do you mean, I’m short volatility? So you go through the explanation, and they say, well, well, then maybe I need a head, maybe I need some long volatility as a hedge in my portfolio, and that’s fine. But then you do get to the place where you say, Okay, wow, this worked really well, I had this long volatility position, going into March of 2020. And it really protected my portfolio because it went through the roof, much more than my stock portfolio went down. But then did you rebalance? You know, did you take the profits from your long volatility position, realize them and reinvest them in stocks? And, you know, that’s really where this provides an enormous piece of value, is to the extent that it can be managed so that the portfolio is rebalanced, particularly when there’s an event a serious volatility event that produces outsized profits from the from the hedge component of the portfolio. But and this is, you know, a big topic in the professional volatility world. You know, how do you monetize a long volatility position? When Yeah, yeah. When How do you do it a little bit now a little bit, you know, do I do I scale out of it? Do I? Do I know that this is it? March 18? Of 2020.

 

Jeff Malec  48:56

Yeah, no, it seems like it was gonna get a lot worse. Right. Right.

 

Jim Carroll  48:59

And, and, and if I monetized today, does my client call me tomorrow and say, You’re an idiot. And so, you know, what to do with a successful long volatility position? Is is an unknown. And, and so one of the challenges of hedging portfolios and of using things like long volatility products as pieces of portfolio construction, is is getting comfortable that you have some heuristics, some rule set some methodology for taking profits, and reallocating them, or to the extent that you have it as a piece of your portfolio, and it does have some bleed component, right? So that your long volatility exposure is actually going down, in you know, ordinary times. How do you how do you? How do you refill that bucket so that when it’s needed, you’ve actually got the full allocation You’re expected to have these, these are not simple questions to answer. And, and as a result, at least the people that I’ve talked to, you know, continue to scratch their heads and they’ve come up with an approach. But nobody’s satisfied that it’s the right approach. And I think there is no right approach, because every one of these volatility episodes is different than as I described to clients. You know, we do not know several things we do not know exactly when we do not know exactly how high and we do not know exactly how long right

 

Jeff Malec  50:41

into that point. You march 18 was at the Vixa. But the mark, market bottom March 24 23rd 23rd. Yeah. So that’s even interesting in of itself, right? Like the VIX peaks coming back down, but you still see the market going down? How do you? Right, so yeah, well,

 

Jim Carroll  50:58

maybe, maybe that’s a signal. Maybe there were a couple of other things you could have seen on the 18th and 19th. That we’re suggesting. And yo back to December of 2018. Saw some of the same things going on?

 

Jeff Malec  51:17

Well, even here in March of 22. Right, I would think we were just doing that for another club, the March of 2020. When we were down 12%, the VIX had gone up 300% or something, and hear this March when at the lows when we were down 12% The VIX was up like 20 Some percent or some. So, yeah, depends the starting level as well, right? Where do you stand being in the volatility space of the gamma phenomenon, that all the all, everything that’s important in terms of volatility is all driven by the market makers and their option hedging? As a thesis?

 

Jim Carroll  51:57

I’ll go first because I know the least. I am, I am certain that is very important. I’m, and I’m totally convinced of one thing. That derivatives as a component of market action and market behavior are clearly bigger and more important than they’ve ever been. Now, having said that, does anybody really have the ability to measure the different components of Derrida’s activity? You know, who’s who owns the puts? Who owns the calls? Who’s short, the calls? Who’s long the puts? Who’s dying? And and how are they all hedged out? And what’s the gamma exposure? And what’s the, you know, Vanna Vega charm, blah, blah, blah, blah, blah. No one has yet convinced me. And most people have offered suggestions that nobody’s got enough information to really know what’s going on. Yeah, you know, in any one place, you look at all the listed stuff, you know, all of the stuff that you can actually collect data on. Okay, so what portion of the overall market does that represent versus all the derivatives that are buried in unstructured products, all the derivatives that are in OTC contracts? I don’t know. And so I have a tendency to say that it shows up in price if you pay attention.

 

Jeff Malec  53:34

And I’ll ask it a slightly different way to you, Stuart, have any thoughts on like retail option, volume has exploded? Option, volume overall has exploded? Does that have any effect on the pricing of volatility on the pricing of vix as it would be reflected in the futures? And in the ETFs?

 

Stuart Barton  53:56

I mean, I’m sure it does the, you know, I’ll pick up on both of those questions. But there has been an increase in volumes in the options and no doubt that that’s new entrants to the market, and many of them maybe maybe retail trading trading options. And of course, that has a has an impact on the market overall. I think in terms of trying to get information out of what you see from from various measures of of Ghana, etc. to Jim’s point, it’s, of course, it’s it’s important information. But it’s incredibly difficult to to reliably say which way around dealers are in any particular group include for gamma, I mean, the best example would be the largest driver of of big individual positions. Physicians are our institutional fliers, for instance, a insurance company or something similar, does a large OTC trade with the dealer It’s a you know, a big bit bank. And that deal is sitting with an enormous pin risk strike risk in a in a particular strike in any underline and hedges it with a bunch of a bunch of listed and it goes, the trader goes chasing around and find what they can suddenly maturities similar strikes all over the place. Let’s say for instance they managed to hedge 50% of the of the OTC using any of these gamma measures, you would say, Well, you know that that that guy it looks like that person is long the hedge if they bought all the stuff so, you know if it’s if it’s long options, this is this is a very long gamma part of the world. And then you drift into that part of maturity and striking only to find out that the OTC is twice the size of the listed that that theme has gone on in they are not long game and they’re very, very short. It’s examples like that, that tell me that these these sorts of strategies or sort of ideas work quite well, a lot of the time I when you’re in a in a very uniformed distributed market, perhaps a lot of retail people have bought lots of different strikes and then kind of estimate whether they learn or short. But as soon as it becomes anything beyond that, I think it’d be very unreliable. And I think it will be unreliable at the worst time you become reliant on it and say, Oh, look, this is a very long game or part of the part of the curve only to find out it’s exactly the opposite. And it goes against you. So yeah,

 

Jeff Malec  56:28

that’s a tough game. And Vance, I’ll ask a slightly different version of view, which I mentioned earlier, the difference between vix and volatility. I think we’ve seen that a lot since 2020. Right volatility has remained elevated vix doesn’t always agree with that. Right? We’ve had clients in long bond funds and actually investing in long Vol by buying options doing different things in the volatility space has not done as well hasn’t shown the prints that the VIX as the cash vix as we as we quote it. So, what are your thoughts on how? How can investors reconcile that in their head of the difference between the VIX and the investable VIX? The VIX futures are the VIX in the volatility.

 

Vance Harwood  57:11

Well, the I guess there’s multiple questions in there. I think always, when you just look, when you when people say volatility, I think in the sense you used was historic, or realized volatility. So that’s looking at the moves of the s&p for the last 30 days and doing the standard deviation, which essentially gives you the volatility of that, that, in quiet times the VIX is is reliably higher than that. And some people call that a risk premium and try to harvest that. The VIX futures, on the other hand, because they are investable, hedges, you know, those are in any sort of market like that there’s got to be a hedge and the hedge for that as SPX options. So I kind of divided into imply and realize volatility on one side, which is historic and mostly a calculation. The implied volatility is what the options are. Our pricing is as the volatility and I think one of the things people don’t realize is the historic volatility metrics are not that great. So for example, if you’re using five day realized volatility, and boy, this is really going to be responsive. Well, it turns out if you have a trending market that can give you a completely bogus answers, because it’s, it’s fooled by the trend. So it would dramatically underestimate. And then there’s also a back end phenomenon. If you’re doing 20 day, and looking back 20 days and you’ve had, you know, a big flurry, there was a spike and everybody say, Oh, we’re okay. And volatility really starts dropping. The historic volatility metric tends to hang on to that old data and look high. So I think you really have to be careful if you’re looking looking at those that comparison that you recognize the the deficiencies in the historic vol metric. And I think the other the other aspect about the VIX and the VIX futures is that it’s a very tough hedge for vix futures to tie that even though it’s based on the VIX, and that’s what it settles to. If you look at it 10 days before expiration, it’s it’s very difficult to do arbitrage on that. And so when that’s the case, there’s a premium for that arbitrage. And that shows up in the gap.

 

 

Jeff Malec  59:38

So what if we if we had to do over again, we went back 20 years, would we come up with something different than the VIX? What What can we come up with that would better track the volatility that everyone sees and feels and well, I

 

Stuart Barton  59:51

mean, I think that the questions only come up because people have decided they want something tradable. I mean, the original idea was, let’s get a number. That’s me. meaningful in some way. And of course it is meaningful and it’s quite, it’s kind of quite an elegant solution. But, you know, when you go down the route of okay, we’d also like it to be tradable. Obviously, that wasn’t thought on that there are, you know, there are pseudo tradable approaches that one could try and implement. It’s unfortunately, quite difficult to have a number that I think would be as interesting to people as the VIX, but at the same time be a tradable number. I think that’s, that’s, I think things like people have said, Well, how about you just use something like, you know, after Moneyball? Well, the problem is, we can we can trade at the Moneyball between ourselves, and it’s near impossible to maintain a dealer’s book in in a product that does that. And there have been attempts in the past. But ultimately, for something to be both interesting and tradable. I think it’ll be it’s, we’re kind of stuck where we are, I don’t know, if there’s a there’s a fantastic solution.

 

Jim Carroll  1:01:02

I know, you know, Scott nations right, and they’re familiar with all the work that he’s do. And, and I look at, you know, his indices. And there are some interesting things you can tease out when you’re comparing VIX, which is a broad strip of in the money at the money out of the money options for the s&p 500 versus volley his measure, which is which is strictly at the money. And so, you know, I think there are there are ongoing tweaks at how you measure implied volatility. And I actually think that the combination and the ability compare and contrast has some value for people who want to be in this space.

 

Jeff Malec  1:01:56

You know, I think that practitioners would just say like price a straddle right like well, the, at the beginning of the month, it was five and at the end of the month, it was one and so volatility went down. You’re like well, but vix was up 20% or something. So that’s where the confusion comes in. Which another way to think of it is fixed strike vol versus floating strike ball right? VIX is kind of floating strike.

 

Jim Carroll  1:02:20

Well, I look you know, if there were no confusion, then we’d all be out of a job. So let’s not let’s not Arad, it’s not solve it right.

 

Jeff Malec  1:02:33

I gotta get everyone’s take on volatility for the rest of the year, where we’re, where we’re at what the curve looks like, where it could go. Disclaimer that none of us know what the future is going to look like. Who wants to go first? Jim? You’d like to utterly saying no way on that. But

 

 

Jim Carroll  1:02:54

look, I have no idea. First of all. But I suspect given that it’s an election year, you know, we got midterm elections, we’ve still got a conflict in the Ukraine. I think that the knock on effects of the conflict in the Ukraine are going to be enormous. We’re seeing it in the commodity space already. And I think it could have ripple effects that are much more deeply economic. So So I am, let’s put it this way. I am prepared for volatility to be volatile for the rest of the year.

 

Jeff Malec  1:03:33

Right. So to be volatile, not to be persistently high. Or

 

Jim Carroll  1:03:38

perhaps both. Perhaps both. Yeah.

 

Jeff Malec  1:03:42

Vance, what are your thoughts? What did you can you do a lot of work on the curb and whatnot. So what are your thoughts on what’s that looking like and how it might look moving forward?

 

Vance Harwood  1:03:51

Well, I think it’s my, my macro observation is the VIX is mean reverting and it over time, it tends to want to go to you know, 1617, kind of in that range, we’ve been hovering at 20. So what it needs kind of jolts along the way to keep it above that point. So we’ve had jolts like that. Certainly, the war in Ukraine has been one of those. So the question is, if we don’t have another one of those jolts, then then then I think we’ll see vol started dropping more down towards towards the mean, certainly we we’ve had had a huge bull run up over the last couple of years. So I think market it’s not unreasonable, it’s digesting that but I guess if anything, I would expect to see volatility easing a bit for the rest of the year.

 

Jeff Malec  1:04:53

Stuart got any thoughts?

 

Stuart Barton  1:04:56

Oh, I would I would not make any forward looking statements of course. Yeah. A comment on a comment on where the volatility is at the moment. You know, I think a lot of people are new traders to the market would say vix futures in the 20s. Wow, that seems it seems high. I feel that remind people that this is this is much more of a normal situation. I think people who got into the market in maybe pre 18 When we saw low teams in the VIX products, you know, I think that was an anomaly that there was the, there were reasons for that. And, you know, obviously, that’s well documented. But I think right now we’re sitting in a in a in a comfortable space and the bowl and the bowl complexes, probably opportunities to the upside and probably have opportunities. The downside role is probably, you know, in quite a healthy, kind of healthy place. And I think the market is better for it.

 

Jeff Malec  1:05:54

Hardest takes can be volatility related can be music related, whatever, whatever you want.

 

 

Jim Carroll  1:06:01

After watching Saturday night, live this week, I’ve become a Lizzo fan.

 

Jeff Malec  1:06:06

All right, that’s a hot thing. What can you What is she saying? I think I know one or two of the songs. But

 

Jim Carroll  1:06:13

yeah, and I didn’t really know many of the songs before, but she’s an incredibly talented entertainer. She was the host Saturday Night Live. And she was also the the artist. And I thought she just crushed it. And I had really never, you know, spent much time around Lizzo before but there you go. I like it. She’s large and in charge. Yeah.

 

Jeff Malec  1:06:38

Who? Stuart Vance got any thoughts? Vance? I’ll ask you what’s at what’s going on with that telescope? That’s speaking of large and in charge?

 

Vance Harwood  1:06:46

Yeah, I got that when I was 15. So that’s I had that a long time. That was the astronomy buff. So definitely. Interested in and cosmology and the the new. The work telescope. I’m following that very closely. I don’t know about the Webb telescope. Yeah, the one that they launched. Just just getting into position right now.

 

Jeff Malec  1:07:12

The Hubble replacement basically. Yeah. And this week, right, there’s going to be for the planets are going to be aligned. I think I saw that on Twitter the other day. What can you see? Can you see Saturn’s rings with anything?

 

Vance Harwood  1:07:26

Oh, yeah. Yeah, no, there was a while back, there was a meteor that hit Jupiter. And it was fun to see because it left this big black spot splotch I could see in the telescope on Jupiter. So

 

Jim Carroll  1:07:40

better there than here? Yeah, absolutely. I

 

Vance Harwood  1:07:42

will be alert for the earth I think I do but

 

Jeff Malec  1:07:45

it is when I gotta had a steak or that was it that we almost got wiped by by a meteor steward. What do

you got?

 

 

 

Stuart Barton  1:07:58

I think my, the process we’ve been through in this in launching these, these, these new ETFs has taught me a few things that that I think are exciting. And that is the world is becoming or the average person in the developed world is becoming more sophisticated in in managing their own finances, etc. Products are becoming more sophisticated as well. But at the same time, I think the regulators are always perhaps a little bit slower, or they cautious as they as they should be. But seeing where we are today and the process we’ve been through with regulators, I’m kind of excited, and maybe cautiously optimistic, that we are going to be able