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VXUP is revolutionary. VXUP could become a key hedge for non-correlated portfolios. VXUP deserves to become a billion-dollar ETF. Spot CBOE VIX Up Class Shares (NASDAQ: VXUP ) could transform investment management. While I am very empathetic to the notion put forth in yesterday’s article that the daily movement of the ETF currently lags the responsiveness of the raw VIX index, the recognition, appreciation, and acceptance of VXUP’s benefits should dramatically increase its trading volume. In turn, the increase in VXUP’s trading volume should make it much more responsive to changes in the raw VIX index. And this increased responsiveness to the raw VIX index will further increase the ETF’s value as a hedging tool, in a virtuous cycle. The general acceptance and adoption of VXUP as a hedging instrument should transform investment management in a variety of ways which I will specifically illustrate. Indeed, I believe that the investment community will quickly realize the immense profitability of promoting a very healthy level of liquidity and AUM in VXUP. Yesterday’s article did an excellent job of explaining VXUP’s mechanics, along with that of its inverse ETF VXDN (NASDAQ: VXDN ). I will not recreate the wheel here. However, I will point out numerous examples of strategies which could be vastly improved by the use of VXUP as a hedging component. Indeed, as a hedging instrument, it is totally irrelevant whether VXUP is perfect. What matters to the investor is whether or not VXUP is a drastic improvement over every other ETP hedging alternative currently available. I will argue forcefully that VXUP is vastly superior. The ZOMMA Index Master Sheet is an exhaustive list of ETP strategy indices and their variations that we have published on seekingalpha and sometimes in books. I forcefully argue that for any of the strategies which use iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA: VXZ ), iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ), or ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ) as a hedging component, that the performance of those strategies could be vastly improved over multi-year periods by replacing the use of VXZ, VXX, and UVXY with VXUP. Theoretically, there are very short, discrete time periods where backwardation could benefit the use of VXZ, VXX, or UVXY. However, it has been definitively illustrated by dozens of studies that over longer times frames, persistent contango tends to cause an uncomfortable amount of performance drag when using these instruments as hedges. On one hand, I have argued that all of the strategies illustrated in the master sheet should no longer be used due to their correlation to long bonds. On the other hand, reducing the size of TMF, and making VXZ, VXX, or UVXY larger percentage allocations in an effort to reduce the strategies’ long bond correlation and diversify hedging sources kills upside performance due to contango lag–equally unacceptable. VXUP would solve this problem elegantly, allowing larger volatility-related hedges, which could reduce the correlation of the strategy indices to both stocks and to bonds, while eliminating contango lag. I have argued forcefully that the nightmare scenario for the financial markets is for both stocks and bonds to crash simultaneously. On 3/11/2015 , I wrote: The sad joke of financial markets is that they are driven by long term interest rates, which set the discount rate for all other asset classes. And indeed, dropping interest rates have made speculators of every stripe look brilliant. Imagine a high jumper who is constantly buoyed by a dropping force of gravity. His athletic prowess appears to be improving, but instead, the force of gravity is becoming weaker. And conversely, rising gravity, or interest rates, cause moving objects to drop to earth more quickly. Moving objects like stock prices, bonds, real estate, and even gold. Every asset class will be affected by rising rates. Since then, the TLT ETF has dropped from $127 to a touch below $117. Imagine a nightmare scenario is which both stocks and long bonds dropped by 50%, due to a spike in interest rates. In such a scenario, it is almost facile and axiomatic to point out that volatility would skyrocket. A hedge like VXUP would be absolutely essential to reduce a portfolio’s correlation to both stocks and to bonds during such a nightmare. Moreover, if stocks and bonds do not simultaneously collapse, a lower correlation to both asset classes will not hurt the investor seeking an authentically non-correlated return stream during more normal regimes. So returning to the issue at hand, the use of VXUP as a hedging tool potentially allows the serious investor to reduce a portfolio’s correlation to both stocks and to bonds without the continuous contango that a VXZ, VXX, or UVXY position would entail. And without contango, the new VXUP volatility hedge could be comparatively larger without the associated drag of pre-existing alternatives. So it is largely irrelevant to the serious investor whether or not VXUP perfectly mirrors the raw VIX index. No hedge is perfect. There are merely hedges which are far better than any available ETP alternative! And VXUP is that far better hedge. As the investment community realizes it and volume in the VXUP increases, ironically, the VXUP should better mirror the raw VIX and even further outpace the competition as the most serious tool in the hedger’s toolbox. The portfolio manager’s dream has always been a continuously traded put option of sorts, which can serve as a shock absorber to a portfolio, without the drawbacks of a put option’s time decay or a volatility future-based instrument’s contango (which some would call synthetic time decay). The VXUP should become that continuously traded put option. Nothing else which has been introduced in the ETF world comes close to the VXUP in achieving that goal. I am not an expert in ETF design, but the goal that VXUP seeks to achieve is exceedingly shrewd. I would argue that increased volume, AUM, and acceptance will make the instrument more robust, useful, and demanded. Disclosure: I am/we are long VXUP. (More…) 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. Scalper1 News
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