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Summary This large ETN is close to its year low and has lost 43% over the past year. As a play on a quiet fall market, is there money to be made when the VIX goes lower? We do an analysis of this heavily traded ETN and answer these questions and more. The VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) is a rather simplistic (on the surface) security to take advantage of a fall in volatility. According to the sponsor, VelocityShares, The ETNs are medium-term notes of Credit Suisse AG (“Credit Suisse”), the return on which is linked to the performance of either the S&P 500 VIX Short-Term Futures™ Index ER or the S&P 500 VIX Mid-Term Futures™ Index ER (each such index, an “Index” and collectively the “Indices”) The ETNs do have a maturity date of December 04, 2030 but for all intents of purposes the maturity only represents a future date for the instrument to be redeemed or perhaps extended. The ETNs pay no interest and there may or may not be a return of principal upon maturity. A majority of investors in this ETF use the vehicle to hedge against lower volatility. The turnover of only 2 days is indicative of this factor. We will analyze the basic structure and provide some of the key risk factors of this instrument that has seen a significant inflow of funds over the past month. A recent overall structure was quite simplistic: XIV Structure, as of September 10 Contract name Weight CBOE Short-term VIX Future Sept 2015 17.00% CBOE Short-term VIX Future Oct 2015 83.00% As noted, with only 17.00% of the futures contract focused on September, the balance now shifted to October one has an opportunity to participate in lower volatility. The underlying question is, is it that simple? Simply by waiting five days we find it is hardly that simple. Here is the revised structure five days later: XIV Structure, as of September 15 Contract Name Weight CBOE Short-term VIX Future Oct 2015 100% The October contract closed at 23.85 on September 10 and at 20.425 on September 15. All contracts from September have now been rolled over to the current month. As many analysts have stated simply the way VIX contracts are priced, investors will gain approximately 5.00% or more a month on the roll-over. This sounds fantastic and would appear to be a simple way to pick up a very nice return. There are multiple issues why this is not that easy or simple. Since this ETF functions as an inverse to the S&P 500 VIX and is really a short vehicle for the VIX in an ETN form the fund managers in Switzerland via their model and the prospectus must buy contracts that are about to expire and sell the next month. This would be defined as a contango strategy. As such, as noted, XIV may very well gain 5% or more per month simply by rolling future contracts (buying back the ones that are about to expire and sell the next month. The ETN must maintain a short position and bias at all times. The only problem is that not only will the fund lose money during market corrections but also when markets move sideways. These sideway moves occur during political gridlock, holiday periods, Federal Reserve indecision, economic malaise, and during electoral seasons, (in general) to name a few. One of the other problems is that the daily indicative value may be higher or lower than the closing price. As such, an investor can go to sleep believing they could not possibly lose money since the market is rallying overseas, while in fact they lose $.50 per share upon market opening. Fortunately, the share price over time has outperformed the indicative prices and the NAV. Presently the indicative price is $28.08 versus a closing price of $27.75 on September 15, according to Velocity Shares. The one month premium average to the NAV or indicative price has been .78%, reflecting the recent market correction. Many times, (including the presently) it trades at a discount. In terms of the market correction, here are some historical prices and percentage changes on XIV and since August 01 (using XIV closing prices and VIX settlement prices): Date XIV Price C hange Percentage Change VIX Futures Prices Sept/ Oct Change Percentage Change Aug 03, 2015 $48.76 NA NA 15.125 15.875 NA NA Sept 01, 2015 $22.01 -$26.75 -54.86% 29.725 25.825 14.60 9.95 96.52% 62.67% Sept 15, 2015 $27.75 -$21.01 $5.74 -43.08% 26.07% 22.575 20.425 7.45/-6.97 4.55/-5.40 49.25%/-23.46% 28.66%/-20.90% Note: The second numbers listed under change and percentage change are intermediate price changes, (since September 01). As noted above XIV has recouped 26.07% since September 01 and is climbing quickly as global markets settle down and rally, but is still down 43.08% since August 03. The October VIX has lost 20.90% since September 01, yet is still up 28.66% from August 01. Unfortunately, one cannot simply device a model or formula to determine the profit (or loss) potential when the VIX rallies or sells off versus the performance of the XIV. The best we can do is state a 1.24-1.50% correlation between the two. In other words when the VIX rallies an investor should loss approximately $1.25 for every dollar in XIV and when it falls gain approximately $1.50. This is not an exact mathematical formula but simply based upon our own correlation analysis. There are simply too many variables that influence the price action for this correlation to be valid over a significant period of time and further analysis is necessary. Investors should also be aware that the ETN has a net expense ratio of 1.35% versus a category average of 1.27%. In addition, the beta of the ETN is -.90 and the Alpha is -1.7 for the past three years. This is obviously almost a total negative correlation to the S&P 500, but not 100% or a perfect -1.00. A recent article in Barrons stated traders have shunned the ETN this month. Investors placed $345.00M in the ETN in late August, while have only put in $18.9M since September 03. The ETN presently has 1.48BLN market capitalization. The Barrons’ writer should have analyzed further why this is so. One way is to review the holdings of the ETN. Yes, many trader’s use this vehicle as a speculative tool. Predominately, there are large funds and institutions that have placed substantial funds in the ETN as a hedge vehicle for their pension and other large institutional investors. For example, Lazard Capital has a particular fondness or appetite for the vehicle, owning 72,250 shares or 1.76% in one of their Institutional Funds. In addition, Credit Suisse (NYSE: CS ) holds a 26.453% stake, UBS (NYSE: UBS ) 6.46%, and Citigroup (NYSE: C ) holds 3.42%, among other firms. Overall, institutions own approximately 74.04%, with mutual funds hold only .49%, according to Fidelity.com. As such, these institutions are not so much traders as they are hedgers. These investors are simply holding at this time and not adding to their position or selling. They have already placed their hedge for the next quarter. As such, they are using it as a vehicle for their overall holdings to take advantage of lower volatility and add “alpha,” without having to directly go to the futures market. In addition, there are many hedge funds that are using the vehicle to take advantage of a decline in volatility going forward. As a retail investor we feel that an investor may participate with the institutions but only with a portion of assets and on a strictly month to month basis. This is our primary reason in analyzed this ETF since August 01. Since the beginning of the year XIV is down 12.05%, but -44.61% since June 24 when it hit a price of $50.10. It is fruitless as a retail investor to use this ETN as a long term investment vehicle. A quarter to quarter investment or hedging tool to take advantage of calming markets and lower volatility is fine. Unfortunately, we would not recommend this vehicle as a long term, let alone cyclical type investment vehicle. The risks are simply too high as a buy and hold investment. Take advantage of the higher volatility, pick up a quick return of possibly 10% riding the wave of lower volatility, but don’t overstay the party. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (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. Additional disclosure: Additional information and analysis is from velocitysharesetns.com, morningstar.com, fidelity.com, yahoofinance.com, tdameritrade.ca, cboe.com, and our own analysis. Scalper1 News
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