Abstract
VIX exchange-traded products (ETPs) provide tracking on the return of a constant-maturity VIX futures index, instead of the uninvestable VIX spot index. In this paper, we develop a comprehensive framework to dissect the tracking performance of regular and leveraged VIX ETPs. In this framework, naïve investors in VIX ETPs expect to achieve the ETP’s leverage ratio multiplied by the VIX return during their holding period, but the actual ETP return can deviate dramatically from this naïve expected return due to four components of return deviation. The index substitution deviation is shown to be the primary driver of the bull (inverse) VIX ETPs’ return erosion (enhancement), which can be explained by the negative roll-yield as a result of the contango term structure of underlying VIX futures index. For leveraged VIX ETPs over multiple holding days, the compounding deviation due to the “constant-leverage trap” can be sizable. In addition, the NAV deviation due to expense ratio and fund management issues is negative, and the inefficiency deviation doesn’t accumulate over long holding periods due to the creation/redemption feature. Our return deviation framework can be generalized to other ETPs tracking indices that are either uninvestable or unrealistic to replicate.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Brenner and Galai (1989) first called for the development of a volatility index and financial instruments to trade such an index.
ETNs are exchange-traded notes (debt instruments) issued by financial institutions with a promised payoff tracking the underlying index with a stated leverage ratio. As warned by FINRA (July 2012), investors in ETNs are exposed to credit risk of these debt instruments. In contrast, ETFs are open-end exchange-traded funds that invest in a pool of actual assets to track the underlying index with a stated leverage ratio. Volatility ETPs (exchange-traded products) are either in the form of ETNs or ETFs, while most stock ETPs are in the form of ETFs. We refer to both ETNs and ETFs as ETPs.
Regular ETPs track 100% of the underlying index, while leveraged ETPs (LETPs) typically track the daily return of an underlying index multiplied by a constant leverage ratio. Double bull and inverse LETPs have a leverage ratio of 200 and − 100%, respectively.
Bakshi and Kapadia (2003) document a negative market volatility risk premium by studying the statistical properties of delta-hedged option fortfolios.
Index substitution refers to the fact that the VIX Exchange-traded Products actually track their VIX futures-based underlying index rather than the VIX spot index.
The main null hypothesis of this paper is that the deviation of actual ETP returns from their naïve expected counterparts is zero. In other words, there is no deviation between the actual ETP returns and the corresponding multiple of VIX percentage changes.
Although the inception date for the SPVXMP family is 11/29/2010, the NAV data in Bloomberg are not available until Friday 11/25/2011.
Valuation Premium is defined as the ETP’s Market price less its NAV and then scaled by its NAV, denoted in percent.
The creation and redemption feature of ETPs allow for easy arbitrage between the market price and NAV of ETPs when the market price is away from the NAV, leading to a negative coefficient of the valuation premium.
References
Alexander, C., & Korovilas, D. (2013). Volatility exchange-traded notes: Curse or cure? Journal of Alternative Investments, 16(2), 52–70.
Avellaneda, M., & Zhang, S. (2010). Path-dependence of leveraged ETF returns. Siam Journal on Financial Mathematics, 1, 586–603.
Bakshi, G., & Kapadia, N. (2003). Delta-hedged gains and the negative market volatility risk premium. Review of Financial Studies, 16(2), 527–566.
Bakshi, G., Madan, D., & Panayotov, G. (2015). Heterogeneity in beliefs and volatility tail behavior. Journal of Financial and Quantitative Analysis, 50(6), 1389–1414.
Bialkowski, J., Dang, H. D., & Wei, X. (2016). Does the tail wag the dog? Evidence from fund flow to VIX ETFs and ETNs. Journal of Derivatives, 24(2), 31–47.
Bordonado, C., Molnár, P., & Samdal, S. R. (2017). VIX exchange traded products: Price discovery, hedging, and trading strategy. Journal of Futures Markets, 37(2), 164–183.
Brenner, M., & Galai, D. (1989). New financial instruments for hedging changes in volatility. Financial Analysts Journal, 45, 61–65.
Charupat, N., & Miu, P. (2011). The pricing and performance of leveraged exchange-traded funds. Journal of Banking & Finance, 35(4), 966–977.
Cheng, M., & Madhavan, A. (2009). The dynamics of leveraged and inverse exchange-traded funds. Journal of Investment Management, 7, 43–62.
Deng, G., McCann, C., & Wang, O. (2012). Are VIX futures ETPs effective hedges? Journal of Index Investing, 3(3), 35–48.
Eraker, B., & Wu, Y. (2017). Explaining the negative returns to volatility claims: An equilibrium approach. Journal of Financial Economics, 125, 72–98.
Goltz, F., & Stoyanov, S. (2012). The risks of volatility ETNs: A recent incident and underlying issues. An EDHEC-Risk Institute Publication.
Lauricella, T., Eaglesham, J., & Dieterich, C. (2012). Chaos over a plunging note. Wall Street Journal.
Loviscek, A., Tang, H., & Xu, X. E. (2014). Do leveraged exchange-traded products deliver their stated multiples? Journal of Banking & Finance, 43, 29–47.
Mencia, J., & Sentana, E. (2013). Valuation of VIX derivatives. Journal of Financial Economics, 108, 367–391.
Shum, P. M. (2011). The long and short of leveraged ETFs: The financial crisis and performance attribution. Working Paper, York University.
Simon, D. P., & Campasano, J. (2014). The VIX futures basis: Evidence and trading strategies. Journal of Derivatives, 21(3), 54–69.
Tang, H., & Xu, X. E. (2013). Solving the return deviation conundrum of leveraged exchange-traded funds. Journal of Financial and Quantitative Analysis, 48(1), 309–342.
Whaley, R. E. (1993). Derivatives on market volatility: Hedging tools long overdue. Journal of Derivatives, 1, 71–84.
Whaley, R. E. (2013). Trading volatility: At what cost? Journal of Portfolio Management, 35, 95–108.
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48, 817–838.
Acknowledgements
The authors thank Gurdip Bakshi (the managing editor), an anonymous reviewer, and seminar participants at the U.S. Securities and Exchange Commission (SEC) in April 2016 and the 2017 Financial Management Association Annual Meetings in Boston for their valuable comments and suggestions. Tang gratefully acknowledges the Institute of International Business at Seton Hall University for its financial support.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Tang, H., Xu, X.E. Dissecting the tracking performance of regular and leveraged VIX ETPs. Rev Deriv Res 22, 261–327 (2019). https://doi.org/10.1007/s11147-018-9149-7
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11147-018-9149-7