VelocityShares Daily 2x VIX ST ETN (TVIX)

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How does TVIX trade?
By: Vance Harwood

•For the most part TVIX trades like a stock. It can be bought, sold, or sold short anytime the market is open, including pre-market and after-market time periods. With an average daily volume of 21 million shares its liquidity is excellent and its bid/ask spread is penny.

•Like a stock, TVIX's shares can be split or reverse split. If fact, TVIX reverse split 3 times in its first four years of existence. The last reverse split was 10:1 and I'm predicting the next one will be around September 2016 with a 10:1 ratio also. See this post for more details.

•Unlike UVXY there are no options available on TVIX.

•TVIX can be traded in most IRAs / Roth IRAs, although your broker will likely require you to electronically sign a waiver that documents the various risks with this security. Shorting of any security is not allowed in an IRA.

How is TVIX's value established?

•Unlike stocks, owning TVIX does not give you a share of a corporation. There are no sales, no quarterly reports, no profit/loss, no PE ratio, and no prospect of ever getting dividends. Forget about doing fundamental style analysis on TVIX. While you're at it forget about technical style analysis too, the price of TVIX is not driven by supply and demand-it's a small tail on the medium sized VIX futures dog, which itself is dominated by SPX options (notional value > $100 billion).

•According to its prospectus the value of TVIX is closely tied to twice the daily return of the S&P VIX Short-Term Futurestm.

•The index is maintained by S&P Dow Jones Indices. The theoretical value of TVIX if it were perfectly tracking 2X the daily returns of the short term index is published every 15 seconds as the "intraday indicative" (IV) value. Yahoo Finance publishes this quote using the ^TVIX-IV ticker.

•Wholesalers called "Authorized Participants" (APs) will at times intervene in the market if the trading value of TVIX diverges too much from the IV value. If TVIX is trading enough below the IV value they start buying large blocks of TVIX-which tends to drive the price up, and if it's trading above they will short TVIX. The APs have an agreement with Credit Suisse that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep TVIX's tracking in good shape.

What does TVIX track?

•Ideally TVIX would exactly track the CBOE's VIX® index-the market's de facto volatility indicator. However since there are no investments available that directly track the VIX VelocityShares chose to track the next best choice: VIX futures.

•VIX Futures are not as volatile as the VIX itself; solutions (e.g., like the iPath S&P 500 VIX Short-Term Futures ETN (VXX)) that hold unleveraged positions in VIX futures typically only move about 55% as much as the VIX. This shortfall leaves volatility junkies clamoring for more-hence the 2X leveraged TVIX and UVXY.

•TVIX attempts to track twice the daily percentage moves of the S&P VIX Short-Term Futurestm index (minus investor fees). This index manages a hypothetical portfolio of the two nearest to expiration VIX futures contracts. Every day the index specifies a new mix of VIX futures in that portfolio. For more information on how the index itself works see this post or the VXX prospectus.

•TVIX's tracking to its target index is not as good as UVXY. I'll get into the details of why later in the post, but on average you pay a premium of almost 2% for TVIX shares relative to the index it tracks, compared to a premium of 0.25% for UVXY. For a security as volatile as TVIX this is not an especially big deal, but worth knowing.

•If you want to understand how 2X leveraged funds work in detail you should read this post, but in brief you should know that the 2X leverage only applies to daily percentage returns, not longer term returns. With a leveraged fund longer term results depend on the volatility of the market and general trends. In TVIX's case these factors usually (but not always) conspire to dramatically drag down its price when held for more than a few days.

•The leverage process isn't the only drag on TVIX's price. The VIX futures used as the underlying carry their own set of problems. The worst being horrific value decay over time. Most days both sets of VIX futures that TVIX tracks drift lower relative to the VIX-dragging down TVIX's underling non-leveraged index at the average rate of 7.5% per month (60% per year). This drag is called roll or contango loss.

•The combination of losses due to the 2X structure and contango add up to typical TVIX losses of 15% per month (85% per year). This is not a buy and hold investment.

•On the other hand, TVIX does a decent job of matching the short term percentage moves of the VIX. The chart below shows historical correlations with the linear best-fit approximation showing TVIX's moves to be about 93% of the VIX's. The data from before TVIX's inception on October 3, 2011 comes from my simulation of TVIX based on the underlying VIX futures.

Most people buy TVIX as a contrarian investment, expecting it to go up when the equities market goes down. It does a respectable job of this with the median TVIX's percentage move being -4.8 times the S&P 500's percentage move. However 18% of the time TVIX has moved in the same direction as the S&P 500. So please don't say that TVIX is broken when it doesn't happen to move the way you expect.

•Most people buy TVIX as a contrarian investment, expecting it to go up when the equities market goes down. It does a respectable job of this with the median TVIX's percentage move being -4.8 times the S&P 500's percentage move. However 18% of the time TVIX has moved in the same direction as the S&P 500. So please don't say that TVIX is broken when it doesn't happen to move the way you expect.

•With erratic S&P 500 tracking and heavy price erosion over time, owning TVIX is usually a poor investment. In fact, even the provider's marketers who you'd expect to figure out a positive spin, state that "The long term expected value of your ETNs is zero." Unless your timing is especially good you will lose money.

Full article: http://seekingalpha.com/article/3557916-how-does-tvix-work