TVIX: Anatomy Of A Disaster…

| May 30, 2012 | 0 Comments

Most people don’t like big surprises when it comes to investing.  But anyone who’s been around long enough knows the markets are full of them.  Sometimes a stock zigs… just when you think it’s about to zag.

And that’s exactly what the VelocityShares Daily 2X VIX Short-term ETN (TVIX) did last week.  Unwary investors got the surprise of their lives when TVIX did a head fake of legendary proportions.

I’ll show you what happened in a minute…

But first, let’s find out what makes TVIX tick.

TVIX is a highly complicated exchange traded note (ETN) meant to track the daily movement of the S&P 500 volatility index (VIX).

As you may know, the VIX is used by professional traders to measure fear in the marketplace.  When investors think a market downturn is coming, they protect their portfolios by buying S&P 500 index put options.  The increased put buying causes the VIX to rise.

And one thing’s for certain, the VIX is volatile in and of itself…

But to make matters more interesting, TVIX is 2X leveraged to the VIX’s day-to-day price fluctuations.  In other words, when the VIX rises 4%, TVIX is designed to rise 8%… and vice versa.

Funny thing is, what TVIX is supposed to do is a far cry from what it actually does.

TVIX collapsed from $15 last week to just under $6 a few days ago. Usually when a stock gets cut in half like this, something’s gone wrong with the underlying company.

But not TVIX…

Nope, the market TVIX was supposed to track- the VIX -was up 9% on the same day this piece of trash was down 30%!  If it had worked properly, TVIX should have been up 18% on the day.  To make matters worse, TVIX dropped another 25% the very next day… ouch!

What went wrong?

The SEC is currently investigating, but apparently TVIX was trading at a hefty premium to the VIX right before last week’s crash.

According to Credit Suisse, the creator of this four-lettered fiasco, TVIX had become “too big for the market it was trying to track”.  As a result, the company stopped issuing new shares of the ETN on February 21st.

But that didn’t stop investors from buying the already available shares. And when they did, they inflated TVIX to a premium over the VIX. According to FactSet Research, TVIX was trading at an 89% premium to the VIX on March 21st.

Things went downhill from there…

Credit Suisse began issuing new shares again on March 22nd.  And that’s when the enormous premium vanished and TVIX came crashing back to earth.  It would be funny if it weren’t for the fact that average investors got completely hosed.

But that’s not all…

Believe it or not, TVIX isn’t the only ETN that took investors to the cleaners over the past few weeks.

The iPath DJ-UBS Natural Gas ETN (GAZ) is designed to track the price of natural gas.  But this heavily traded asset had the same problem as TVIX.  The investment bank behind the ETN- Barclays -stopped issuing shares.  And that had the ETN trading at an eye-popping 134% premium to its benchmark.

It was just a matter of time before this one went in the toilet…

And flush it did- GAZ plunged 50% from its March 19th highs.  At the same time, natural gas prices dropped a mere 7%.

And listen to this…

Even after the recent rout, GAZ still trades at a 64% premium to the natural gas benchmark it’s designed to track.  It goes without saying, be very careful if you’re holding GAZ in your portfolio.

Is there a lesson to learn from these ETN horror stories?

You bet there is…

Always do a little fact checking before you invest in ETFs and ETNs.  A little due diligence on your part will help keep your portfolio out of trouble.

Before you buy an ETN, take a few minutes and go to the issuer’s website.  Make sure the current price isn’t trading at a lofty premium to the ‘daily indicative value’ or ‘net asset value’.

If it is, it means the ETN isn’t tracking the underlying market it’s designed to reflect.  And that means you should steer clear at all costs…

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Category: ETFs

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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