Lower Priced Is Not the Same As Low Priced
If you fall off of a ten foot ledge, but catch yourself half way down, the good news is that you have only five feet left to fall. However, if you own a stock that falls by 50%, there is no good news - it still has 100% left to fall before it hits $0.00.
One Solution to Two Non-Needs
Today I would like to submit for your consideration an idea that belongs in the (now defunct) SkyMall catalog - the receptacle famous for taking different bad ideas of things that you don't need and combining them into unnecessary gizmos. Need a new bidet sprayer? No? Need a digital accessory caddy? No? Why not combine the two!
Biffy Butler Bidet Sprayer / Digital Accessory Caddy
This is how the thinking goes at Skymall. It is also how the thinking goes at ProShares - take a questionable product, another questionable product, and combine them together! What could go wrong?
From a post on my blog in 2012,
Volatility, in and of itself, is neutral to expected value but investors appear to be utterly price-insensitive in attempting to avoid it. With the emergence of faddish financial innovation in the form of various exchange traded notes, it is convenient for investors, including low information retail investors, to express this preference in the capital markets.
Over the past year, this trade has represented an almost perfect transfer from volatility avoiders to expected value seekers. Perhaps the most infamous example is the iPath S&P 500 VIX Short Term Futures ETN (VXX). This security has an expected value of $0.00 over time (and can be directly shorted via either the equity or indirectly via equity derivatives) but serves the purpose of near-term volatility avoiders in the interim. It allows both sets of investors to achieve their stated aim. Over the past year, it is down by over 84%; it will probably achieve similar results in the future.
If you like it slow and smooth, you can go with VXX (expected value: $0.00); if you like it fast and rough, you can go with TVIX (expected value: $0.00). But wait, there's more. What if you are the kind of guy who likes playing Russian roulette with five bullets and want to put a bit of leverage on this idea? I am glad that you thought of that because the same folks that brought you volatility exchange traded securities also brought you leveraged exchange-traded securities.
Constant Leverage Trap
Leveraged exchange traded funds and notes suffer from an ailment called the "constant leverage trap" (there may be a cure for it on SkyMall; it might be worth checking before it is too late) in which the investment's management company has to add to their leveraged securities when they go higher and subtract from those securities when they go lower in order to maintain their mandated balance between equities and debt. If this sounds like the exact opposite of the cliché advice to "buy low and sell high", that is because it is. They are not necessarily stupid people managing these securities; they are simply people doing their jobs within their disclosed mandates. At one time or another, I have shorted, written calls, or bought puts on a majority of these securities, most recently the Direxion Shares Exchange Traded Fund Trust (NYSEARCA:RUSS).
So what exactly happens when you start out with a volatility exchange traded security and then combine it with leverage? You get the Biffy Butler Bidet Sprayer/Digital Accessory Caddy of Investments, ProShares' Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY).
If TVIX is VXX on crack, then UVXY is VXX on krokodil (in the name of all that is good, if you don't already know what this stuff is, then do not look it up). From afar, they all appear to have the same downish tendency:
But up close you can tell them apart better:
If you are treasurer of the endowment at Al-Qaeda or an affiliated group, then please buy these securities. For the rest of us, our portfolios may benefit over time from shorting VXX, TVIX, and especially UVXY. With a little time and a little mean reversion, they will decline. As for Biffy Butler Bidet Sprayer/Digital Accessory Caddy, one might consider the alternatives of just taking a shower and then, when finished, just holding digital accessories with your hands.
Disclosure: The author is short RUSS, UVXY.
Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital. Rangeley invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our investors, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.