UVXY: Make Volatility Great Again
Summary
- Ultra VIX Short-Term Futures ETF is a 1.5x leveraged fund that tracks short-term market volatility.
- Primed to closely replicate the daily return of the S&P VIX short-term futures contract, UVXY provides a toolbox for tactical volatility plays.
- Part of the leveraged ETF family, this product by nature mechanically depletes over time.
- Not a long-term hold – but rather a go-to in times of heightened volatility, multiple strategies exist to use UVXY to capitalize on times of renewed fear.
- But with volatility suppressed, we see if explosive profits can still be reaped by tracking this derivative-based Molotov cocktail.
This article was amended on 5/6/2021 to reflect a correction in the hypothetical scenario calculations.
Brief Overview
Equity markets Vintage 2021 must be one of the strangest thus far. If the investment banking equivalent of Marty McFly were to jump into a plutonium fueled DeLorean, go back a year to describe future events, most traders would fall off their chairs. Literally.
Who would have dreamed of US capital markets characterized by a bunch of tendie-eating millennials waging war on large hedge funds, defending their civic rights to hold stonks firmly with diamond hands? Reddit chat groups and easy access to high octane options on video game-like trading platforms (Robinhood) have gradually become weapons of mass distraction as American youth, perplexed with continual lock downs, seeks escapism through get rich quick schemes.
SPAC-mania has been thrust upon us, with gurus doing copious amounts of cheer leading to explain why such a skewed deal structure is the nirvana of net worth. Even celebrated sports stars have launched their own SPACs, as they swing for the fences, in an all-out assault on capital markets.
All this kind of smacks of 1980s Japan when Central Bankers created an environment primed for a gargantuan asset boom. At that time, Nissan Motor Company's investment arm was making more trading securities than manufacturing cars. Sound familiar? Bitcoin on your balance sheet, anybody?
Bill Wang showed us that CFDs (contracts for difference) may be the new WMDs as he YOLO-ed his way to hedge fund stardom, advancing ultra-leveraged lines with several investment banks. It all seemed too good to be true - banks were making fees, Bill was making more cheddar than Dairy Farmers of America, and GSX finally got a bid despite numerous question marks regarding its opaque financials. But something was missing.
Despite Janet Yellen's attempts to spike interest in volatility by suggesting interest rates should be raised most recently, volatility has been missing in action. Gone are the days of Volmaggedon which saw a plethora of ETN blow-ups. Feeling somewhat left out of the action since the implosion of XIV, Credit Suisse dived knee-deep into Archegos Capital credit line extensions just to mix it up a little. Value at risk, eat your heart out - Nothing like a good crisis.
And we have lost perchance one of the most volatile, unorthodox, fly-by-the-seat-of-your-pants presidents the modern world has ever seen. Regardless of your political affiliation, politics has become tamer - with that drop in TV ratings only matched by the spike in taxes soon to be inflicted on all Americans to pay for a sustainability spend-athon. Who is a better purveyor of your capital - surely the government, right?
Yes, RIP volatility - with Central Banks conspiring to prop up markets, free flow capital unleashed, everything seems a little ordinary. Maybe the results of the past presidential election would have been different under the mantra "make volatility great again".
Source: Capitalist Exploits
Enter our explosive ETF companion, the Ultra VIX Short-Term Futures ETF more commonly known as BATS:UVXY. An everyday staple among a range of tactical products which provide trading opportunities on the state of volatility. Comparably liquid, the ETF trades like a stock with ~79 million shares changing hands daily.
Notwithstanding, the similarities pretty much end there - owning the ETF does not give residual ownership in an underlying firm. Sales figures are non-existent, valuation ratios are meaningless and there is no management discussion and analysis, let alone earnings.
Not easy to appraise a leveraged, comparably complex product - destined to implode. A bearish call would be suitable, but this is not really an investable asset.
More Bud Fox than Buffet, this is one for your short-term tool kits to facilitate swings in volatility. Understanding the product's entrails provides a better idea of how to use it, when to and through which means. Make volatility great again! Neutral.
Source: Market Chameleon
Product Details
The Ultra VIX short-term futures ETF, as its prospectus highlights, is a commodities pool affording investors daily leveraged exposure to near-term VIX futures, engineered principally to catch volatility in the S&P 500.
Daily is a key term as, like most of its leveraged peers, this is for succinct trades only. Not at all one of those buy-and-forget securities which multiply over a given holding period. Returns often diverge from the 1.5x leverage factor, due to underlying product mechanics.
Futures is another key product word - as the commodities pool-based ETF does not technically deliver leveraged returns on the VIX itself, but instead on the underlying front and second month futures contracts.
In an ideal world, the ETF would track the CBOE's VIX index, which is the de facto vol indicator. The next best thing, in the absence of available investments tracking the VIX, remains VIX futures.
Yet VIX futures are not as explosive as the VIX itself, leaving volatility junkies continually looking for a fix - the simplest answer has been to crank up leverage 1.5x. Having said that, previously the ETF was tracking 2X, so this too has somewhat evolved.
A swift glimpse at 1-year total returns for the leveraged volatility package visually demonstrates the perennial decay intrinsic to it. Another central factor behind the products continual losses is the characteristics of Contango in futures contracts.
For UVXY to fulfill its mandate, the fund buys and sells futures contracts (front month and back month) on a continual basis. Rolling the futures contract forward, by selling the front month and buying the back month, is a costly exercise during periods of Contango - as this implies consistently selling low and buying high. Over time, this leads to the price decay.
A glimpse at simplified 1-year total returns emphasizes the implosive nature of the 1.5x leveraged ETF
Source: Tradingview
It is crucial to understand the intricacies behind leverage factors - the 1.5x factoring only applies to daily percentage returns, not long-term ones, signifying that this is - with massive roll costs and expense ratios to boot - not prime stomping ground for a long-term staycation.
Very much a get-in, get-out trade than an until-death-do-us-part investment.
Leveraged ETFs normally suffer from enduring decay due to the math behind compounded returns.
- As a starting point, take the index (VIX in this instance) trading at $100 (hypothetical). The 1.5x leveraged ETF would theoretically trade at $100 too.
- If the index drops 25%, (to $75), the 1.5x leveraged ETF will lose 37.5% of its value (to $62.50).
- Subsequently if the index then advances 50% (to $112.50), the ETF will move to $109.375. As you can observe, the index has moved above its initial level but the 1.5x leveraged ETF still languishes lower.
- By nature, US securities markets have marginally more up days than down days (see graphic below). Due to this, each positive movement on the index will create a 1.5x decline in the ETF, making it virtually impossible for the ETF to recover its losses subsequently. This is the prime reason that UVXY has been in a constant state of decline since inception requiring more splits than a US corporate billionaire, to stay afloat.
Cumulative 20-year historical distributions of SPY underscore the positive tilt - over this period, there have been 55% positive observations v 45% negative ones. As UVXY essentially gains value on negative observations, this describes why the product lastingly implodes.
Source: Market Chameleon
Key Product Characteristics - UVXY
Source: Spreadsheet developed by author with data inputs from ETF.com
The World's Biggest Short - Don't Matter Just Don't Short It
Just because this product has embedded decay engineered into it does not make it a perfect short - to the contrary.
Only possibly bettered by natural gas futures contracts - aka the widow maker - or more exotic power market derivatives (ask Einar Aas - a Norwegian power trader), UVXY is immensely explosive to the upside in rare times of heightened volatility.
That combined with growing margin requirements mandated by worried brokerages makes it almost an impossible hold - diamond hands or not.
A rapid look at UVXY's price action during March last year, when Bill Ackman spent most of his time buying credit default swaps and telling us the world was going to end, fully underscores the products ability to launch into orbit.
March 2020 demonstrated to us just how explosive UVXY can be - over approximately a 28-day period, the ETF sky-rocketed 918% (!)
Source: Tradingview
So, the question arises - how do you trade it? In short, both quickly and using risk defined derivatives contracts to safeguard portfolio margin and cap losses. In my experience, the best way to successfully generate returns is by consistently monitoring price action and placing bear call spreads underneath the product once it has popped significantly.
For example, during March 2020, as the ETF propelled itself to the stratosphere, the concept would be to sell a call contract with several weeks to expiry and combine this with buying a call contract at a higher strike. This effectively creates a bear call spread where the profit made on the position is the maximum credit when placing the trade, while the maximum loss is the distance between the strikes on the options contract.
Given that the product has natural tendency to decay, provided you factor in enough time for the ETF to find its natural glide path downwards, the bear call spread general eventuates in a profit. Holding the ETF short rarely works as, specifically during times of heightened volatility, hard to borrow fees make it uneconomical to ride to the bottom.
For illustrative purposes only - a theoretical example of a bear call spread where I sell a call contract at a lower strike and buy a call contract (to define risk) at a higher strike (both contracts at the same expiration) Be careful of Ex-dividend dates as the short call, particularly if in the money, will automatically be assigned to you, forcing you to pay the dividend.
Source: Market Chameleon
Key Takeaways
- Ultra VIX short-term futures contract is a 1.5x leveraged ETF tracking short-end-of-the-curve market volatility.
- The ProShares volatility offering is predominantly used as a tactical play on near-term market reversals.
- Its leveraged nature, big roll costs and heft expense ratios, means it is not a long-term investable asset.
- The package suffers from natural depletion as rolling front month futures contracts to buy later month ones, particularly during periods of Contango (upward sloping futures curve) implies buying high and selling low. This, combined with the 1.5X leveraged nature, makes it atypical in the asset class panorama.
- But the ETF is far from the perfect short - in times of heightened volatility - it has been known to explode more forcefully than a SpaceX rocket.
- The product's ability to rip to the upside, pushing margin requirements to the brink of implosion, and propelling hard to borrow fees to the stratosphere, means holding the ETF short is rarely feasible.
- Instead, shorting pops via the options market (bear call spreads) rather than buying pops (bull put spreads) seems a more practicable route to volatility stardom. Regardless, the product is not for the faint of heart. Pack extra batteries for that pacemaker.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (21)
The same with The VXX.
The Sh__ will hit The Fan at some point but not until The Dems stop giving out Money to The Non Rich.
