Traders rushing to protect against declines in the Standard & Poor’s 500 Index created so much demand for an exchange-traded note tied to equity volatility that Credit Suisse Group AG (CSGN) stopped issuing shares.
Switzerland’s second-largest bank suspended the creation of new stock in the VelocityShares Daily 2x VIX Short-Term ETN on Feb. 21 after its market value more than quadrupled in 2012 to a record $694.4 million, data compiled by Bloomberg show. Shares outstanding have surged 699 percent since Dec. 30 as the S&P 500 climbed 8 percent and posted its best January gain since 1997.
Demand for products that let investors hedge equities has surged during a four-month rally in global stocks. The Credit Suisse note tracks the Chicago Board Options Exchange Volatility Index, or VIX, which moves in the opposite direction of the S&P 500 about 80 percent of the time. The structure of the ETN known as TVIX (TVIX) makes it harder for Credit Suisse to offset risk, said Fred Bethon of X-Change Financial Access LLC.
“That particular ETN has grown so large that it’s imprudent to continue issuing shares,” Scott Maidel, a senior money manager for equity derivatives at Russell Investments in Seattle, said in a phone interview yesterday. Russell oversees about $141 billion. “That massive amount of volatility that needs to be traded to hedge the ETNs is a risk.”
ETNs are unsecured bank debt backed by their issuer’s credit, unlike exchange-traded funds that hold assets. Banks create and redeem shares of ETNs based on the level of demand for the securities. That demand doesn’t affect the price since the ETNs track the performance of an index. Both the TVIX, which aims to generate twice the daily return of an index tracking the VIX, and Barclays Plc’s iPath S&P 500 VIX Short-Term Futures ETN (VXX) are based on VIX futures.
Halting issuance was “due to internal limits on the size of the ETNs,” Credit Suisse said Feb. 21. Existing holders may continue to redeem their notes with Credit Suisse or trade them, the bank said. Katherine Herring, a New York-based spokeswoman for Credit Suisse, declined to comment further.
The TVIX climbed as high as $17.86 yesterday, or 12 percent above its net asset value, according to data compiled by Bloomberg. When Barclays suspended issuance in its iPath Dow Jones-UBS Natural Gas Total Return Sub-Index ETN in August 2009, the note traded 15 percent higher than its net asset value a month later.
“You’ve increased the risk that it will diverge from the benchmark that it’s trying to replicate,” Steve Sosnick, equity risk manager at Timber Hill LLC, the market-making unit of Interactive Brokers Group Inc. in Greenwich, Connecticut, said in a phone interview yesterday.
Equity investors bought volatility products after enduring unprecedented price swings in 2011 when concern about Europe’s debt crisis pushed the Dow Jones Industrial Average to alternate between gains and losses of more than 400 points on four days for the first time ever in August. Daily share swings in the S&P 500 averaged 2.2 percent that month, the most for any August since 1932, Bloomberg data show.
The four largest ETNs that rise in value when the VIX rallies have added $908.6 million in market capitalization since the beginning of the year, according to data compiled by Bloomberg. The number of shares outstanding in Barclays’s iPath S&P 500 VIX Short-Term Futures ETN, the largest VIX-tied ETN, reached the highest level in six months last week. The average number of TVIX shares that changed hands daily this month was 22.1 million, versus the 2011 average of 2.25 million.
VIX Versus Stocks
The VIX rose 32 percent last year, its biggest annual gain since 2008, as stocks around the world slid. The MSCI All- Country World Index (MXWD) fell 9.4 percent on concern the European debt crisis was spreading and global economic growth was slowing. The U.S. volatility gauge reached an eight-week high on Oct. 3, when the S&P 500 (SPX)touched a one-year low. That day, the TVIX reached $100.90, the most since November 2010.
The VIX was unchanged yesterday at 18.19. It has declined 62 percent since the more than two-year high reached on Aug. 8. The index is 12 percent below its 22-year average of 20.56, data compiled by Bloomberg show.
“With this sideways and complacent volatility environment, it’s awfully difficult for these funds, especially on the short term, and in the VIX, to make any type of money,” Bethon, a managing director for strategy and execution at X-Change, said in a telephone interview yesterday.
The TVIX slipped 0.7 percent to $16.90 yesterday, bringing its decline since Oct. 3 to 83 percent and leaving it 59 percent below the average of $41.08 since the fund was started in 2010.
Drop From Peak
The S&P 500 fell 0.3 percent to 1,357.66 yesterday, its first drop in four days, after failing to hold above its April 2011 peak of 1,363.61, the highest level since June 2008. The benchmark gauge for American equity has rallied 3.5 percent in February and is poised for a third straight month of gains, the longest streak in a year.
The halt in TVIX issuance will lessen demand for VIX futures, said Nelson Saiers, who oversees about $650 million at Alphabet Management LLC in New York.
VIX futures through October declined yesterday, with March contracts falling the most. April futures on the VIX settled at 24.55, or 6.36 points higher than the level of the gauge, according to data compiled by Bloomberg. The gap widened to 7.02 points on Feb. 17. The last time two-month futures were that high was July 2010.
“One of the bids for the VIX will be reduced,” Saiers, who uses options to bet on the volatility of stocks and other assets, said yesterday in a phone interview. “One potential consequence of this move is that the floor on the VIX and S&P 500 volatility could be lowered.”
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