One of the most important stories in the world of volatility so far this year is the tale of General TVIX. After outstanding performance in 2011 and a rise to prominence following the Debt Ceiling debacle and Europe / Greek catastrophe, TVIX was the vehicle of choice for many that sought to trade volatility. For a good portion of 2011 and into 2012 there was a running theme found in the Stocktalks here on Seeking Alpha regarding the movements of "General" TVIX and his fight against the market forces bent on his destruction.
Sadly, it appears that the opposition forces have gotten the upper hand and TVIX has been demoted from his command position. Upstart UVXY has taken up the slack with additional interest going to less leveraged alternatives like XIV, VXX and VQT. Gone are the days of the charge of General TVIX, and rightly so.
Charges of the Court Martial
As can be seen from the chart, General TVIX has a spotty history over the long term. This is of course to be expected out of any leveraged product, and TVIX, being based on twice the performance of front and 1 month forward VIX futures, is no different.
While spot VIX has moved from 19.45 to 22.22 since TVIX's inception, TVIX has gone from 106.27 to 8.79 in the same time period. Contango steadily ate away ate the General's army until the Debt Ceiling and Europe brought TVIX back up above it's opening price. Anyone that had followed General TVIX into battle after initial issuance would have been able to make a profit or at least get out even.
Thusly a band of TVIX faithful were created and TVIX became the premier volatility trading product for those that could not trade VIX futures directly. Sadly, this popularity would prove to be fatal for TVIX due to its very nature.
ETF vs. ETN - The Debate Continues
VXX, UVXY, XIV, VQT - All of these products are ETF (Exchange Traded Funds) that attempt to mirror the moves in the VIX futures. There is no asset underlying shares in these products. By purchasing a share, you are buying a product that will vary in price based on the performance of the VIX futures that the ETF is set to replicate. There will never be a discrepancy between the price of an ETF and the performance of the replicated index as the price always fluctuates in line.
TVIX is a different animal.
As an ETN (Exchange Traded Note), TVIX is fundamentally divergent from its ETF brothers. ETN's are like an ETF in that they are built to track the performance of an underlying index, but they do this by purchasing bonds, futures or some sort of security to complete the matching. Since the ETN is linked to an underlying security but also trades on an exchange like a stock, you can get situations where the demand for the security raises the price above the value of the covered assets. the only way to prevent this variance is to continue to issue shares of the ETN until the value of the fund equals the value of the underlying assets.
In the case of TVIX, this happened when Credit Suisse (CS), the firm that runs TVIX, halted share issuance on February 22, 2012. Due to the nature of ETNs, as the demand for TVIX increased, Credit Suisse had to continue issuing shares to keep TVIX in line with the NAV (Net Asset Value) of the underlying VIX Futures it was based on. As soon as they stopped share issuance, the value of TVIX started diverging from the underlying.
The reasons for the halt were fairly straightforward. As the number of shares increased and interest continued driving TVIX up, Credit Suisse had to buy more and more VIX futures contracts to cover the additional shares. At one point Credit Suisse was accounting for 90+% of the daily volume in VIX futures to rebalance the TVIX to the underlying. This increased buying pressure was artificially inflating the VIX futures market, causing a distortion that would not stop until either demand for shares was eliminated or new share issuance was halted. Credit Suisse chose the only path available and set General TVIX on the path towards destruction.
With share issuance halted, demand for front and 1 month out VIX futures plummeted. This was felt by volatility ETF owners within a week of the issuance halt. Surprising many, TVIX wasn't feeling the pressure since no new shares were being issued. Many traders, seeing UVXY and VXX getting smashed while TVIX held steady, actually started getting into TVIX as the "safe" bet on further volatility. While the various volatility ETFs were falling apart, TVIX actually rose higher than before the issuance halt while each day brought it farther and farther away from its NAV.
The final day of reckoning came about on March 22, 2012. The General started the day only slightly red from the previous day and immediately was beset by selling. 14, 13, 12, 11, the General was going down faster than anyone thought possible. There were those that had been warning of the massive disconnect between NAV and Price but they had been wrong for almost a month and no one expected such a fast collapse. After the bell on March 22, the news justifying the implosion finally arrived, Credit Suisse was considering issuing more shares of TVIX.
In one day, TVIX erased most of the Price to NAV discrepancy as people heard the news before the official announcement and abandoned the poor General. In the following days TVIX came down to the NAV of the Futures it is meant to mirror, though it still trades with some premium, likely due to Credit Suisse not following the same issuance levels as before.
After Action Report
Hopefully the story of General TVIX and his defeat at the hands of his commanding officers, Credit Suisse, gives you some insight for the following recommendation.
Avoid TVIX. Use the Volatility ETFs instead.
Trading volatility is difficult enough. Don't bother yourself with concerns over whether Credit Suisse will add uncontrollable variables to your trade by messing with TVIX. If you are already long TVIX, look to sell on strength and switch over to a more predictable product, as predictable volatility products can be at least.
General TVIX fought valiantly and there may be some gains left in his future, but I would rather put my money on a product that does not depend on Credit Suisse to succeed.