The Derivative - What’s New about the New -1x/+2x VIX ETFs SVIX and UVIX, w/ Stuart Barton, Jim Carroll & Vance Harwood

Episode Date: April 21, 2022

A little over four years since 2018’s Volmageddon, and 2 years after TVIX got terminated – two new VIX ETF’s were recently launched – the 1x short VIX exposure SVIX and 2x long VIX exposure UVIX by VelocityShares. What’s different about them, how do they protect against another Feb of 2018 event. We’re going straight to the source(s) to answer those questions and more; chatting up three musketeers of VIX expertise: Stuart Barton CIO of VolatilityShares, Jim Carroll of the @Vixologist Twitter handle, and Six Figure Investing blog writer Vance Harwood. They join us to talk through just what is innovative about this new approach, and why such innovation was necessary. This all-star trio talks us through the plumbing behind these new VIX products (including their new index construction/design, rebalancing methodology, and VIX vs.VIX futures), why all levered ETFs suffer from Volatility drag, why futures based ETFs suffer from Contango, and what can be done about those two issues, knowing the difference between ETPs, ETNs & ETFs, what’s in store for volatility the rest of the year, and everything else having to do with VIX futures. Plus, we get an interesting insight into their hottest takes! Chapters: 00:00-01:28 = Intro 01:29-21:08 = The newly launched UVIX and SVIX – a new (better?) way to Rebalance Daily 21:09-33:21 = The Negative effects of Volatility drag & Leveraged ETFs 33:21-46:17 = The alphabet soup that is ETPs, ETNs & ETFs 46:18-01:01:59 = Benefitting from Volatility drag & the Gamma phenomenon 01:02:00-01:05:16 = Future of Volatility? 01:05:16-01:12:52 = Hottest Takes From the Episode: Check out The Derivate podcast episode: $TVIX gets Terminated – What^%$#    Toroso Advisors  |  Six Figure investing Blog  |  Volatility Shares   Follow along with the guys on Twitter: Jim Carroll @vixologist Vance Harwood @6_Figure_Invest and Stuart Barton @VolatilityStu Don't forget to subscribe to The Derivative, and follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Happy National High Five Day. Yeah, it's a thing. Look it up. Excited for the next few weeks here, where we have Swiss Quant Artur Sepp coming on. Then the boys at Resolve talking return stacking and the crazy trend following moves like short bonds that we've seen so far this year. It's also World Creativity

and Innovation Day, which leads us into this episode and the innovative approach to two new VIX ETFs out on the market. A 1X short VIX, symbol SVIX, and a 2X long VIX, symbol UVIX, by volatility shares. Here to talk through how these work, why past efforts in the ETP space short VIX, symbol S-V-I-X, and a 2X long VIX, symbol U-V-I-X, by Volatility Shares. Here to talk through how these work, why past efforts in the ETP space have fallen short, and everything else having to do with VIX futures are an all-star trio, Stuart Barton, CIO of Volatility Shares, Jim Carroll of the VIXologist Twitter handle, and six-figure investing blog writer Vance Harwood, who's been picking apart VIX exposures for as long as I've been following VIX movements.

Send it. This episode is brought to you by RCM's VIX and volatility specialists and its managed futures group, who've been helping investors access volatility traders like Jim Carson, Chris Cole, and Mutiny Funds for years. It can help you make sense of how and when volatility makes sense as an asset class. Check out the newly updated VIX and vol white paper at rcmalternatives.com under the education menu and white papers link. And now back to the show. All right. Welcome everyone. We've got the three musketeers of volatility trading here. Is that good? Are musketeers respected or panned? I don't know. I don't know. But in that context, I meant for it to be respectful.

We've got Vance Harwood of Six Figure Invest, Stuart Barton of Volatility Shares, and Jim Carroll of Toroso. Did I say that right, Jim? Yes. Toroso Advisors, which you told me once again before on the pod, that's like a shark mashup or something what is it no it's it's bull and bear in spanish bull and bear got it i think i made the same mistake last time asking if it was a shark um so wanted to get everyone on to talk about the new volatility etfs that have come out a long long time coming. And start with Vance, who had a nice post on Twitter, kind of digging into what's going on here, bringing up a lot of interesting pieces of the new products. So Vance, what did you find interesting about these products and what can you tell us?

Okay, so actually as a bit of foreshadowing, in 2012, I was doing a blog post on leveraged ETS. And in the blog, I was working through Apple. If you did a 2x Apple and just what would that take? And I was trying to understand kind of the next level of details on the leveraged ETFs. And the thing that struck me when I was looking at this was when you have leveraged ETFs, let's say a times two long or a minus one inverse, is the way they typically operate, at the end of the day, they need to rebalance so that they perform the correct way the next day. So 2X, they rebalance. So next day, they'll continue to do twice the percentage move of today's move. And the minus one, they have to do the same thing.

But the thing that really surprised me was that the rebalancing needed to be in the same direction. So you have a short fund and a 2X long fund. And yet at the end of the day, they're both rebalancing in the same direction. So you have a short fund and a 2X long fund. And yet at the end of the day, they're both rebalancing in the same direction. And that was really non-intuitive, but if you think about it a little bit. Same direction as their stated goal of I'm a long or short or same direction as each other. They're both either buying or both selling. Got it. And so, for example, if the VXX or VIXY goes up 10%, then a 2X is going to want to go up the next day about twice that. So if it's gone up 10% today, they actually need to add

assets so they track that next day's move. On the other hand, the inverse fund, since the market, the volatility went up, they're now overexposed. So they need to reduce their position, but they're short. So the way you reduce the short position is you buy shares. So, you know, this struck me as, you know, my background is electrical engineering, and this is something called positive feedback, where the market goes up 10%. And then you at the end of the day, you add on, you buy more, so that's going to tend to drive it up more. So at that point, I thought, well, that's a weakness. And if that market is small, then you could have kind of a chain reaction.

And then fast forward to 2018, with the 5th of Feb 2018, this wasn't a small market. This was actually a big market with the VIX futures and maybe $10 billion in open interest. But you had huge volatility funds with XIV, SVXY, UVXY. And so all those assets after a huge, you know, 100% move in the VIX, then there were billions of dollars at the end of the day that had to all go in the same direction. So, and, you know, the market, just the liquidity dried up at that point. And we had this last 15 minutes was a disaster from a liquidity standpoint. Right, the tail wagging the proverbial dog, right? What S&P was only down 4% or something? Yeah, that was a significant, but not unusual at all from the magnitude there. So going forward, thinking about coming again with a 2X long and a minus one inverse, you know, that's a huge issue is how do you avoid

doing that again? Let's not make the same mistake again. And so I think the construction of that sticks and UX is really designed to avoid that sort of a scenario. And let's dive into that construction a little bit. Stuart, you're available to talk about that construction? Sure, pass it to Jim. I think I can say a little, you know these products are um are not for everyone and i i recommend everyone to go and read the read the prospectus which is obviously available publicly on our website and elsewhere um so with that said yeah i absolutely agree with what van said there's um there's been an interest in leveraged and inverse products. And I think when some of the early products were designed,

they didn't have the hindsight that we have today. And what that's meant is we're sort of in a better position to look at what the potential problems are and improve upon them or at least do what we can to try and let them suffer from fewer problems. In our case, we decided to go back to the drawing board. So all previous VIX products had tracked very similar indexes. The SPVX SP and its kind of similar indexes effectively track the performance of a portfolio of VIX futures month one and month two

from settlement on day one to settlement on day two and day two to day three and so on. So you've got the settlement to settlement performance, which if one wants an elegant solution, that of course is a very elegant one. The settlement is published. It's very easy to access and so on. The problems with that arise when one gets involved in the need to rebalance

and the leverage in inverse space. So it probably wouldn't surprise you that the first product that obviously tried to track this index was the VXX from Barclays ETN. And of course, that product's not leveraged or inverse, so it doesn't have a rebalance need. So it doesn't necessarily suffer from the same problem. So going from a settlement to a settlement is simpler because there's no need for this rebalance. As soon as you get into the rebalance needs, a settlement isn't necessarily the best target for a fund to try and hit. What it does is it means the portfolio manager has to try and get as close

to or replicate that settlement, which can be difficult. In the VIX markets, a market for trading of settlement was established and became quite liquid, the trade of settlement or TAS market. And that market as a sort of a separate market to the cash futures market for VIX grew considerably as the leverage in inverse products grew. Now, that was sort of a solution to the problem, i.e. the managers were able to hit that settlement relatively easily by putting orders into a trade settlement market and every day effectively getting the settlement or very close close to it the problem with it

is it puts an enormous reliance on one market that sort of prints and executes all at the end of the day and if anything should go wrong with that market it it it it leaves everybody in a very weird situation whereby they may or may not be able to rebalance the funds that they thought they were going to rebalance. And I think February 5th, there's a lot of speculation on how it came about. But I think what we do know is something went wrong in that TAS market. A TAS market that had grown outside of the VIX futures cash market, a market that people had come to rely on, and something went wrong. And as soon as something went wrong, we sort of noticed how anybody trying to rebalance this sort of scale of products in such a short time can cause a

or a market disruption can be the outcome. So we've been lucky enough to look at that history and say, well, let's go back to the drawing board. Let's redesign an index. Let's go right back to actually designing an index that might be more sustainably trackable by leverage and inverse products. And that's what we did together with Acebo. We spent at least a year working with them on the short vol and then later the long vol indexes.

And those indexes do a few things differently, but perhaps the most important one is they measure their performance from a TWAP of the last 15 minutes of trading in the underlying VIX futures miscatch to the TWAP the following day. And some may say that's a very subtle difference. It's 15 minutes of trading versus a settlement price. But what it does is it moves this need to rebalance from a single moment in time to a period of time. And, you know, I think we believe and other market participants we've spoken to believe that that's a significant improvement if one as an index, if one was planning to track it with a fund. And just to clear that up and whoever wants to jump in.

So the products have, instead of whatever the VIX closes at on today, Tuesday, it's whatever the 15-minute TWAP is of VIX closing prices on today. Yeah, that would, I mean, maybe Jim or Vance will be able to tell you more. But I mean, the reality, that's what it comes down to. There is a mix with the TAS also structured into the index. So it's actually half the TWAP and half the TAS close. And the TAS, for lack of a better term, right back in the old days where you'd be watching CNBC and they're waiting for some stock to open because the specialists have to match the flow, right? The buys and the sells before they give an opening price. Essentially TAS is the reverse of that of like, hey, we got to match

all the buys and sells at the settlement. No, it's not an auction is my understanding. It's more of the sense of during the day you can put in TAS orders. Say, I want to buy or sell a certain amount of futures at the settlement price. And there's a sweetener possibility there. If the market is going one way or another, you can say, I'll pay the settlement price plus, you know, half a basis point or something like that. So that accumulates during the day and you actually get a confirmation on that, you know, if it's going to go in, you get a confirmation. So that's an order that's in. And then, you know, whatever the CFE has a settlement process, it ends up with a number.

And then that's typically quite close to the last trade, unless there's some sort of abnormality. That's where the TAS comes from. If I just add one thing that I think, because a lot of people misunderstand that TAS market, and I think it's uncommon, I think, for non-professional investors to deal in it. It's typically dominated by the institutions. The key difference between it and, for instance, a market on close order that, you know, we have these in equity,

you can give your broker a market on close order and you can execute it at close. The difference here is this is a parallel book. This is an order book that runs in parallel to the VIX futures cash market. So if I put an order in and say, I'd like to buy the settlement and somebody would be making a market in settlement, maybe it's minus one and plus one basis points above and below settlement, and I want to buy 50 futures at settlement, I can put that into it. I can pay a basis point over settlement for my execution. And I am done at the time that I have taken that market,

that I've lifted that offer. So unlike a market of clothes, you can phone your broker back 10 months later and go, actually, take me out of the clothes. I don't need to do that order anymore. I am done. If I want to go back the other way, I have to put another order in now to sell the settlement and put my futures in and hit the bid.

So it is a parallel book that trades together with the cash market. But to me, it seems like it could break more. If there's $5 billion to buy on the settlement, on TAS, and zero to sell, doesn't it get, in theory, could get out of whack, that parallel book could be way out of whack of what the futures are doing?

Well, I think Vance had some comments on that. Because I think, Vance, what was the, there was a, what happened was there was a market, there was like a market up, market down limits on the TAS. Yeah, Vance, I'm sure. Yeah. So at that point in time, the CBOE had a 0.1 point limit on how much the offset, how much sweetener you could put in on the TAS order. And my understanding, this is second or third hand, but well before the end of the day, the market kind of seized up because no one was interested in taking the other side of the market. I think the most likely buys because the market was, the volatility was spiking up. So the TAS market basically ground to a halt. There was no, you know, parties on the other side that were interested in negotiating on the TAS order. And then they would flip to, okay, I got to still get it done. So I'm going to do it,

mark it on close. You know, again, second or third hand, you know, the pro-sharers wasn't able to, you know, this is speculation, but the speculation is pro-sharers were typically using the TAS market. And when that TAS market goes away, then you're left with the situation of, okay, now I have to go into the open market while it's spiking up or aftermarket. It was a possibility. And they ended up paying a lot less to do the rebalance than they would have if it had used the TAS market. So for their shareholders, it ended up being a good thing, but it was a chaotic situation. So just one final notice. Since then, the CBOE has increased that from 0.1 to 0.5 is how much of that offset.

So they've increased that offset by a factor of five. And they've also, well, they've moved it to 4pm instead of 4.15, which I think is good because now it's aligned with the equity market. And the other thing CBOE has done is they've added a volume weighted average price calculation the last 30 seconds before close. And so those are three things that I think have all made the VIX close and settlement more robust from where it was in 2018. Just to emphasize something that came up earlier, VIX versus VIX futures, because we're not talking about the VIX here. We're talking about VIX futures. And in the case of all of these products,

that is some blend of typically the front month and the second month VIX futures, you know, depending on where we are in the expiration cycle. And, you know, in the day, and I guess we do still have VIX M, there are products that trade the further out VIX futures. But again, it ain't the VIX. These are VIX futures that may or may not reflect whatever's happened to the VIX on a given day. Well, because to get into that, you can't trade the VIX itself, right? That's correct. So you could approximate it, but how many options would you have to buy

or hold? I gave up even trying to think about that a long time ago because people with a lot more brainpower than I have concluded that it was a fool's errand to try to replicate the VIX in any kind of trading way. And when we mentioned the cash fix earlier, were we talking about like OEX options and the actual price of certain options or what were you talking about cash fix? I think typically when people are referring to cash fix or spot fix, they're referring to the quoted VIX index. And so no, it's not cash in the sense that you have, as Vance and Stuart referred to, a cash market for VIX futures versus a TAS market for VIX futures.

If somebody says cash VIX to me, I'm assuming they're talking about a spot VIX quotation. Got it. Based on the calculation using a broad strip of S&P 500 index options. Leave you with the floor here, Jim. What are your thoughts on some of the articles of like, hey, four years after Volmageddon, new VIX ETFs, levered VIX ETFs, there's kind of painted with a negative brush. But for you and what you do in your work, like these are invaluable products. So talk a little bit about who, what type of investors can be using these and why it's not necessarily an evil thing. A weapon of mass destruction. Exactly. Like Warren Buffett

describes the derivatives that abound in his portfolio. Please stay away. Don't use them. They're all for me. And I think going back to Volmageddon, going back to Feb 15, actually, let's go back a little further because I think the rub really began when people discovered the short ball products, XIV grew to be the biggest. SVXY was the alternative. And in 2016, 2017, when the markets were relatively calm, basically upward sloping. And the VIX index volatility, however you want to measure it, whether it's implied volatility using the VIX index, historical volatility, all forms of volatility, we're just grinding down to historically low levels. And so being short the VIX futures, when that VIX term structure is in contango, and we can explain that, but basically it was a one-way trade. XIV was up, let's round it, 90%?

Something like that. It might have been more than that from start to finish. And so when something like that happens, people pick up on it. And people were piling into this sure thing, short volatility trade. There's this stock called XIV. Right. We had the Wall Street Journal piece on the target manager who'd made a couple million bucks and all that stuff. Exactly. So how does that work? I can't remember the name of them now. There was the ultra long natural gas ETF and the ultra short natural gas ETF? U-gas and D-gas.

And if you put a chart of them, they both went basically down to zero. So it doesn't make sense. They should be opposite. But in the fixed and inverse fixed, they don't both erode to zero because of rebalancing. How do you explain that? Because of rebalancing and because in round numbers, 80% of the time, the VIX term structure is in contango. So if you just sit short on that term structure, you're going the periodic circumstance where the market has a hiccup and the entire term structure lifts. And so it's still in contango, but it's in contango two or three

or four or five points higher, and you've had a bad day. If you can recognize that it's just a bad day and the term structure remains in contango, you might want to keep your short position. Maybe you've got some hedging around it, but it's when that term structure flips from contango to backwardation, which is one of the things that happened in early February, 2018, then that's going to be more than just a bad day if you are short volatility. And the bottom line is that if XIV was $2 billion of AUM going into February 5th of 2018, I would wager that $1.8 billion of that did not understand the difference between contangular and backwardation in the VIX term structure and what the real risks of being short volatility are. And as a result, we've all collected stories of people who lost huge sums of money in that set of circumstances. and want to express a view about whether it's a good time to be short volatility or long volatility. And whether, you know, you take Chris Cole's adage that, you know, there's only one this because it struck me that this was a way to get tactical exposure to in a very different way.

You know, I was used to taking tactical exposure through exchange traded funds that represented different asset classes, different geographies, you know, fixed income, equities, commodities, et cetera. And when I began my own investigation of these volatility products back in 2014 and 2015, it was just a little light bulb that kind of went off and said, you know, this is another way to express a tactical view on where the world's going. And as a result, you know, I was a big user of XIV in 2016, 2017. Got out in the middle of January of 2018, because, you know, the system that I use said, said it's not safe anymore. But I think unless you have some way of protecting yourself, and that can be either tactically buying and selling these things or hedging your exposure in some fashion, you know, you could be short volatility over here and have some VIX call options to protect you if all hell breaks loose as a way to hedge a portfolio. There are a bunch of different ways to do it. And again, there are people much smarter than I am out there playing in this field, but there are use cases for

this in the right hands. You've got leveraged ETFs across the landscape, you know, triple this and quadruple inverse that. And they're really no different, no less safe than this. And I think the great thing from my perspective, uh, that Stuart and his team have done is, is they've taken as, as he said, the benefit of hindsight to re-engineer these products and make them safer. Yeah. Like I think of TLT right now, right? Like a safe product bonds with an inflation hedge, right? It's down 30%. If you had a triple levered TLT, you'd be down 90%. Yeah. Go look. There is an ETF ZROZ that is long dated zeros.

Yeah. Zero. Nice ticker. So much for protecting your portfolio with a fixed income sleeve, right? And talk a little bit of… I know some of the firms make the disclosures, make you have to have the disclosure, right, of this isn't for long-term holding. This is, as you used the word, tactical. So, on the long side, for sure, it seems that way of like, you shouldn't just buy and hold this thing for three years. It's going to erode, right? Because of the VIX reverting down to the cash, which we talked about price every month.

On the short side though, we could argue that, right? Is that, we're basically saying the contango premium is higher than the negative carry of the rebalance but i think the situation in there is you still have dramatic drawdown so yeah yeah so when you have uh the volatility spike then volatility takes off and and you get i i think my data said there have been two ninety% drawdowns since 2005. So, you know, buy and hold, you know, if you hold it long enough, but, you know, not many people are willing to tolerate a 90% drawdown. So I think, you know, best practice is to have some strategy that mitigates that, either

an exit strategy, as Jim mentioned, or some sort of option strategy to limit your downside. Yeah, but even with, I'm trying to get at, even without the spikes, right back to that natural gas long and inverse, right? They both went to zero just because of the rebalance cost. Right. So does anyone have data on what that rebalance cost is? Whether it's any leveraged ETF, not necessarily these. Yeah. The aspect of this, there's two things, as Jim mentioned, there's the contango, which is very hard on the long funds and good for the short, the inverse funds. The other aspect is something called volatility drag that all leveraged funds suffer from. But the formula for that is really nonlinear.

So for example, a 2x long and a 1x short, the volatility drag per period is the volatility squared. So if volatility doubles, then you've got a 4x increase in volatility. If you're a 3x, then that goes to three times the volatility squared. So even though you've just gone from a 2x to a 3x, the volatility drag triples. So that's why you see these 3x funds, both the long and the short, going to zero is because any sort of contango gains or any sort of beta in the market gets swamped out by the volatility drive. Got it. You win. That was the answer I was looking for. Well, I think the other thing that has caused people, well, and look, look at the trading volumes in what I'll call the 1.0 volatility ETPs, UVIXI, SVIXI, VIXI,

the trading volumes are still quite large. So there are obviously people out there using these things every single day. Now, how many of those are sophisticated hedge fundy kind of people versus retail investors? Good question. Don't have the answers. But one of the reasons that people don't like these products and don't like this space is because as you were suggesting, if you're long these products, you're quote unquote bleeding to death waiting for a payoff, right? And if you're long these products, you're, quote unquote, bleeding to death, waiting for a payoff.

Right. And if you're short these products, you're picking up pennies in front of the steamroller. I mean, that's that's I prefer freight train. But, yeah, same concept. Yeah. You know, well, and you can certainly hear a freight train coming and if you don't get out of the way, then you probably deserve to be run over. But, um, you know, that's my bias because I do believe that, you know, these products can be safely deployed in the hands of somebody who understands how they work, how the VIX complex works, and how to mitigate what are structural biases. There's a structural bias for the short

volatility products to go higher as the market goes higher. There's a structural bias for the long volatility products to bleed and only have occasional payoffs. And therefore, if you're looking for something to just stick in your portfolio and forget about, don't use these. Yeah. You'll do what the state of California did with their alleged Universa position that they exited before March 2020 because it was bleeding too much. Yeah, and I'll take it as that. Don't use any ETFs that use futures that have contango and backwardation. You're going to get chewed up. You need to know what you're doing or you need to have an advisor who knows what he or she is doing. And let's talk for a second, Stuart.

These are ETFs, right? So just quick definitions we've thrown out. ETPs, exchange-traded products. ETNs, exchange-traded notes. ETFs, exchange traded products, ETNs, exchange traded notes, ETS, exchange traded funds, all somewhat interchangeable, but important differences. So XIV was an ETN, right? And in the prospectus, they had to basically blow it out at, what was it, down 85%? 95.

95 to save the firm, right? Like they have to have the positions to back the note. It was a note drawn on the credit worthiness of the issuer. So they had the option to terminate. And they, if it went down a certain amount, I think 80% in the, in the case of XIB and they, they chose to do that. They could have, they could have kept running, but they chose to terminate. And then it's a good point you bring up.

I think that the market is a little confused about the difference between ETNs and ETFs. And sometimes I see professionals even getting it wrong when they write in the press. So, yeah, the key difference, obviously, one is a fund, one is a note. A note is much more like a piece of credit, and a fund is like any fund that we know. And the real difference in the big space is one is sort of a promise

to pay a payoff by a bank, in this case, Credit Suisse Barclays were the main issuers of the notes and are the main issuers of the notes and are the main issuers. Whereas ETFs actually hold assets. They hold cash and they hold futures, either long or short, but they actually hold what they're trying to track. And the difference there, I guess, is it becomes important when you get to the fringes of operations. For instance, if we went into a terrible banking crisis,

volatility might spike and go to incredible highs. And you might think, well, my note issued by a bank is going to, my big sleek note is going to make me a great deal of money. Well, it is possible in that situation that your note might go to zero, might go down because the creditworthiness of the bank that issued it may be impaired. Whereas in a fund, the actual assets that you've invested and others have invested sit in the fund.

That's one difference. The other one, and I think it's important to remember that most of the horror stories we've heard about VIX-linked products have unfortunately been in the ETN space. And it's sort of because the ETN is a cleverly devised workaround in order to issue something rather than a fund that we all kind of perhaps better understand. And one of those facets that failed the ETN product structure in the VIX space is this idea that if you issue a note that has a certain payoff, it's down to the bank and its traders to hedge that. And they can hedge it however they wish,

but of course, it's in their interest to either have to absolutely hit the hedge spot on, not make or lose a dollar, a dollar more. But it's actually slightly in their interest to beat that benchmark. So it is unlike a fund where if the trading portfolio management team did a little better on a day, they beat the index benchmark. The gains in that situation go to the fund holders. It did a little better, did a little worse, but that economic impact sits with the fund holders. With a note, that's different. It puts note issuers into a strange conflict of interest where it's in their interest to either nail the benchmark or improve on it. And of course, if there's potential profit to be made, it's likely one would err on that side rather than err

on the side of losses. So, you know, I think things like that are starting to become more known, and I think it's starting to mean that notes are being, or the operation of the trading activity behind notes is starting to be questioned. But VIX products have been very much at the center of that because there's been so much activity and because some of those notes were so large.

Well, imagine that you're looking, I can't remember what you said, Jim, but 2017 of the short VIX trade and you're the bank that has to give that exposure. Someone for sure is in the bank saying, hey, if we just book this ourselves, we made an extra billion dollars last year, real money. So- Robert R. Well, go back to 2020,

where if you were fortunate enough to think this pandemic thing might cause a little panic in the markets. And you bought TVIX in February of 2020. And it went up 25 times to its peak in March. And your credit sweeps because TVIX is a note on your balance sheet. And suddenly it's an $8 billion line. Dwarfs the bank all of a sudden. And, and, and gee, what happens if this thing, you know, keeps going, yeah.

Keeps going or hits a bump or whatever. And so TVIX effectively has disappeared. I mean, it still exists, but Credit Suisse said, yeah, we're going to delist this. Yeah. Well, we had a nice pod with you, Jim, saying TVIX gets terminated. So we'll put that in the show notes. But I feel like investors feel it's their God-given right to always be able to trade that ETF. And issuers are like, hey, we have to actually put on trades and do... Investors kind of ignore the mechanics and just say, it's my right to have this. And what we just saw this year, Barclays said, which nobody knew at first what was going on, but we're halting creations and redemptions. Turned out because they forgot to fill out the right paperwork or whatever,

but right. Like people are going nuts of what do you mean you're halting? I need to do more of this. So the ETF sort of solves that, right? You get rid of the ETN problems, but what other issues does the ETF bring besides having taken two years to get through the SEC? One other advantage of SVIX and UVIX, and I think this is unprecedented, is there's also an agreement to not trade more than 10% of the VIX future volume. I think it's a 15-minute period. Is that correct, Stuart? Yeah. So we've committed to stay below 10% of the volume during any 15-minute rebalance period, but able to extend that rebalance period. Yeah.

So what this effectively does is prioritize the stability of the market and the impact that these funds have on the market instead of prioritizing tracking the index. So, for example, Credit Suisse really didn't have a choice. Legally, they were tied to the index. And whatever the index did, they pretty much had to follow. Whereas ProShares as an ETF, they certainly seek to follow the index, but when push comes to shove, they don't have to follow that. And it's really about their assets, not the index. So when you get into these extreme situations, that's a big difference between the ETNs and the ETFs.

Trey Lockerbie, But as as an investor how do i think about that of okay i'm not going to get the pop that i think i'm going to get or i'm going to get 90 of it or 98 of it or well in the case of almageddon both the long and the short fund did better because they because pro shares didn't track the. So that's where this volatility drag kicked in big time. The volatility was so huge that the single-day volatility drag was a huge impact on XIV. I think, and to add to what Vance is saying, I think it's important to understand that,

and Vance started with his point, that leverage inverse products that have to rebalance frequently rebalance in the same direction. But more importantly, they can be rebalancing against the interests of the holders. the hedging bank would have been buying futures in a rising futures market, which no doubt would have caused some further rise in the value of those futures, which lowered the value of the note. So it gets itself into a potential feedback loop. Now, if you are legally obliged to pay the payoff of an index and you are sitting with the need to hedge that because you don't want

to make a loss internally um you get this as i as i pointed out this um uh you've got different motivations here you've got well i really do need to need to cover this but i might cover it and it's not in the interest of my shareholders to cover it or the unit holders to cover it. And it's a weird situation to be in. I would have hated to have been in that situation on the day that the banks were in with their notes. But a very strange one to be in. And as Vance pointed out, by not continuing to rebalance, which I think is what ProShares did, they didn't go against the interests of their shareholders in their favor.

Because by pushing further, we could just push the products further against them and the rebalance would be more expensive. And talk through that for me one second. So if I have $10 million in ETF, long ETF, VIX rises 10%, although we can talk later. We're not supposed to quote VIX in percent, but- Cullen Roche- We do. I do occasionally. Robert Leonardus The VIX futures rise 10%. Cullen Roche- Yeah, the VIX futures rise 10%.

Now I've got, what did I say? Now I've got 11 million in exposure, so I have to buy that extra 1 million. But did my futures increase or I still only have a 10 million base? So explain how those mechanics work for me. Well, I mean, simply put in the case of, I think, FedFed, which I think you're- Well, just any old day when i have to rebalance yeah well in general if you've got a 1x if you've got a if you've got a 1x long then you're right your portfolio is just tracking the futures but if you've got a 2x long then then you do have to go out and buy more to maintain your 2x exposure i think i think that the important point here that's about the tracking is if your activity pushes the underlying against the interests of the

shareholder in the in the say for instance in the vix on fifth push the vix futures higher you're in the situation where the short product buys back too many of its fixed futures so adversely affects it in that way if you get a recovery the next day which we did and but in the uh in the long the two times products that on that day the tvix um effectively leveraged up more highly than it than it needed it bought more futures more than it needed more than bought more futures, more than it needed, more than possibly it would have needed if there wasn't so much buying activity.

And then when we got the recovery the next morning, it lost more value than it needed to. So to Vance's point, he's sort of saying, well, both products, long and short, effectively got harmed by what happened on Feb 5th, at least if you measure over a period of time longer than the one day, because by Feb 6th, Feb 7th, both products had been adversely harmed by that activity. Right. The issue is you didn't know a priori what was going to happen on And let's talk about the good side of volatility drag, right?

So if I'm using the long product and I can rebalance into my beta, into my stocks, which have since come out, right? That's the whole idea behind tactically using the product, right? Or even into the short ball then. So I think we've spent a lot of time on the negative. Who wants to tell me some of the positives of the product, right. Or even into the short ball then. So I think we've spent a lot of time on the, on the negative. Who, who wants to tell me some of the positives of the product? Well, so I think what you're, what you're getting at is, is if you view this as a piece of a portfolio, uh, giving you long volatility, let's go back. And because I have to remind people of this all the time, I say, well, you know, how's your portfolio position from a volatility perspective? Well, what do you mean? It's it has no bearing on. I say, well, do you own stocks?

Well, yeah, of course I own stocks. Well, then you're short volatility. What do you mean I'm short volatility. So you go through the explanation and I say, well, well then maybe I need a head. Maybe I need some long volatility as a hedge in my portfolio and that's fine. But then you do get to the place where you say, okay, wow, this worked really well. I had this long volatility position going into March of 2020 and it really protected my portfolio because it went through the roof much more than my stock portfolio went down. But then did you rebalance? Did you take the profits from your long volatility position, realize them and reinvest them in stocks. And that's really where this provides an enormous piece of value is to the extent that it can be managed so that the portfolio is rebalanced, particularly when there's an event, a serious volatility event that produces outsized profits from the hedge component of the portfolio.

But, and this is a big topic in the professional volatility world, how do you monetize a long volatility position? Yeah, when? Yeah. Yeah. When, how do you do it a little volatility position? Yeah. When? Yeah. Yeah. When? How? Do you do it a little bit now? A little bit later?

Do I scale out of it? Do I know that this is it? March 18th of 2020? Yeah. No. It seemed like it was going to get a lot worse, right? Right. And if I monetize today, does my client call me tomorrow and say, you're an idiot?

And so what to do with a successful long volatility products as pieces of portfolio construction is getting comfortable that you have some heuristics, some rule set, some methodology for taking profits and reallocating them, or to the extent that you have it as a piece of your portfolio, and it does have some bleed component, right? So that your long volatility exposure is actually going down in ordinary times. How do you refill that bucket so that when it's needed, you've actually got the full allocation you expected to have? These are not simple questions to answer. And as a result, at least

the people that I've talked to continue to scratch their heads and they've come up with an approach, but nobody's satisfied that it's the right approach. And I think there is no right approach because every one of these volatility episodes is different. As I described to clients, we do not know several things. We do not know exactly when, we do not know exactly how high, and we do not know exactly how long. And to that point, March 18th was at the VIX high, but the market bottom March 24th? The 23rd. 23rd? Yeah.

So that's even interesting in and of itself, right? Like the VIX peaks, it's coming back down, but you still see the market going down. How do you… Yeah. Right? So you can't… Well, maybe. Maybe that's a signal.

Right. Maybe there were a couple of other things you could have seen on the 18th and 19th that we're suggesting. And you go back to December of 2018, you saw some of the same things going on. Well, even here in March of 22, right? I would think we were just doing that for another client of the March of 2020, when we were down 12%, the VIX had gone up 300% or something. And here this March, at the lows when we were down 12%, the VIX was up like 20-something percent or something. So yeah, depends the starting level as well, right? Where do all of you stand being in the volatility space of the

gamma phenomenon that everything that's important in terms of volatility is all driven by the market makers and their option hedging as a thesis? I'll go first because I know the least. yeah i am i am certain that it's very important i'm i'm i'm and i'm totally convinced of one thing that derivatives uh as a component of market action and market behavior are clearly bigger and more important than they've ever been. Now, having said that, does anybody really have the ability to measure the different components of derivatives activity? You know, who owns the puts?

Who owns the calls? Who's short the calls? Who's long the puts? And how are they all hedged out? And what's the gamma exposure? And what's the, you know, Vanna Vega charm, blah, blah, blah, blah, blah. No one has yet convinced me.

And most people have offered suggestions that nobody's got enough information to really know what's going on. You know, in any one place, you look at all the listed stuff, all of the stuff that you can actually collect data on. Okay. So what portion of the overall market does that represent versus all the derivatives that are buried in structured products, all the derivatives that are in OTC contracts? I don't know. And so I have a tendency to say,

I'll bet it shows up in price if you pay attention. And I'll ask it a slightly different way to you, Stuart. Any thoughts on retail option volume has exploded option volume overall has exploded does that have any effect on the pricing of volatility on the pricing of VIX as it would be reflected in the futures and in the ETFs I mean I'm sure it does the uh you know I'll pick up on both of those questions but um there has been an increase in in volumes and the options and no doubt that's um that's new new entrance to the market and many of them may be maybe retail trading trading options and of course that has a that has an impact um on the market overall um i think in terms of you're trying to get information out of what you see from from measures of gamma, et cetera.

To Jim's point, of course, it's important information, but it's incredibly difficult to reliably say which way around dealers are in any particular Greek, including gamma. I mean, I'll give you the best example would be the largest driver of big individual positions are institutional flows. For instance, an insurance company or something similar does a large OTC trade with a dealer, let's say, you know, a big bank, and that dealer's sitting with an enormous pin risk, strike risk in a particular strike in any underlying, and hedges it with a bunch of listed, and he goes, you know, the trader goes chasing around and finds what they can, similar maturities, similar strikes all over the place.

Let's say, for instance, they managed to hedge 50% of the OTC. Using any of these gamma measures, you would say, well, you know, that guy, it looks like that person is long the hedge. They bought all the stuff. So, you know, if it's long options, this is a very long gamma part of the world. And then you drift into that part of maturity and strike only to find out that the OTC is twice the size of the listed that that dealer's got on and they are not long gam and they're very, very short. It's examples like that that tell me that these sort of strategies or sort of ideas work quite well a lot of the time, i.e. when you're in a very uniformly distributed market market perhaps a lot of retail people have bought lots

of different strikes and kind of estimate whether they run or short um but as soon as it becomes anything beyond that uh i think it would be very unreliable and i think it it'll be unreliable at the worst time you know you become reliant on it and say oh look this is a very long gamma part of the part of the curve only to find out it's exactly the opposite and it goes against you. So, yeah. That's a tough game. And Vantel, that's a slightly different version of you, which I mentioned earlier, the difference between VIX and volatility. I think we've seen that a lot since 2020, right?

Volatility has remained elevated. VIX doesn't always agree with that. We've had clients in long vol funds and actually investing in long vol by buying options, doing different things in the volatility space has not done as well, hasn't shown the prints that the VIX has, the cash VIX, as we quoted. So what are your thoughts on how can investors reconcile that in their head of the difference between the VIX and the investable VIX, the VIX futures or the VIX and the volatility? Well, I guess there's multiple questions in there. I think when people say volatility, I think in the sense you used was historic or realized volatility. So that's looking at the moves of the S&P for the last 30 days and doing the standard deviation, which essentially gives

you the volatility of that. In quiet times, the VIX is reliably higher than that. And some people call that a risk premium and try to harvest that. The VIX futures, on the other hand, because they are investable, the hedges, you know, those are any sort of market like that. There's got to be a hedge and the hedge for that is SPX options. So I kind of divided into implied and realized volatility on one side, which is historic and mostly a calculation. The implied volatility is what the options are pricing as the volatility. And I think one of the things people don't realize is the historic volatility metrics are not that great. So, for example, if you're using five-day realized volatility, you say, boy, this is really going to be responsive. Well, it turns out if you have a trending market, that can give you completely bogus-day, looking back 20 days and you've had a big flurry, there was a spike and everybody's like, oh, we're okay and volatility really starts dropping. The historic volatility metric tends to hang on to that old data and look high.

So I think you really have to be careful if you're looking at that comparison that you recognize the deficiencies in the historic vol metric. And I think the other aspect about the VIX and the VIX futures is that it's a very tough hedge for VIX futures to tie that, even though it's based on the VIX and that's what it settles to. If you look at it 10 days before expiration, it's very difficult to do arbitrage on that. And so when that's the case, there's a premium for that arbitrage and that shows up in the gap. So if we had to do it over again, we went back 20 years, would we come up with something different than the VIX? What could we come up with something different than the VIX? What could we come up with that would better track the volatility that everyone sees and feels?

Well, I mean, I think the questions only come up because, you know, people have decided they want something that's tradable. I mean, the original idea was let's get a number that's meaningful in some way. And of course it is meaningful and it's quite, it's kind of quite an elegant solution. But, you know, when you go down the route of, okay, we'd also like it to be tradable. Obviously that wasn't thought of.

There are, you know, there are pseudo tradable approaches that one could try and implement. It's unfortunately quite difficult to have a number that I think would be as interesting to people as the VIX, but at the same time be a tradable number. I think that's, you know, things like people have said, well, how about you just use something like, you know, at the money vault?

Well, the problem is we can trade at the money vault between ourselves and it's near impossible to maintain a dealer's book in a product that does that. And, you know, there have been attempts in the past, but ultimately for something to be both interesting and tradable, I think it's, we're kind of stuck where we are. I don't know if there's a fantastic solution there. Yeah. I know, you you know Scott Nations, right? And you're familiar with all the work that he's trying to do.

And I look at his indices and there are some interesting things you can tease out when you're comparing VIX, which is a broad strip of in the money, at the money, out of the money options for the S&P 500 versus Volley, his measure, which is strictly at the volatility. And I actually think that the combination and the ability to compare and contrast has some value for people who want to be in this space. And I think that practitioners would just say like price a straddle, right? Like,

well, at the beginning of the month, it was five. And at the end of the month, it was one. And so volatility went down. And you're like, well, but VIX was up 20% or something. So that's where the confusion comes in, which is another way to think of it as fixed strike vol versus floating strike vol, right? VIX is kind of floating strike. Well, and look, if there were no confusion, then we'd all be out of a job. So let's not eradicate all of it. Let's not solve it right here. I got to get everyone's take on volatility for the rest of the year. Where we're at, what the curve looks like, where it could go.

Disclaimer that none of us know what the future is going to look like. Who wants to go first, Jim? You looked utterly saying no way on that. Look, I have no idea, first of all. But I suspect, given that it's an election year, we've got midterm elections. We've still got a conflict in the Ukraine. I think that the knock-on effects of the conflict in the Ukraine are going to be enormous. We're seeing it in the commodity space already.

And I think it could have ripple effects that are much more deeply economic. So let's put it this way. I am prepared for volatility to be volatile for the rest of the year. Right. So to be volatile, not to be persistently high or perhaps both.

Perhaps both. Yeah. Vance, what are your thoughts? You do a lot of work on the curve and whatnot. So what are your thoughts on what's that looking like and how it might look moving forward? Well, I think my macro observation is the VIX is mean reverted. And over time, it tends to want to go to, you know, 16, 17, kind of in that range. We've been hovering at 20. So it needs kind of jolts along the way to keep it above that point. So we've had jolts like that. Certainly, the war in Ukraine has been one of those. So the question is, if we don't have another one of those jolts, then I think we'll see vol start dropping more down towards the mean.

Certainly, we've had a huge bull run up over the last couple of years. So I think market, it's not unreasonable, It's digesting that. But I guess, if anything, I would expect to see volatility easing a bit for the rest of the year. Stuart, got any thoughts? I would not make any forward-looking statements, of course. Perhaps I'd comment on where the volatility is at the moment. I think a lot of people, new traders to the the market would say, you know, VIX futures in the 20s. Wow, that seems high. I think it would remind people that this is much more of a normal situation.

I think people who got into the market in maybe pre-18 when we saw low teams in the VIX products, you know, I think that was an anomaly that there was, there were, there were reasons for that. And, you know, obviously that's well documented, but I think right now we're sitting in a, in a, in a comfortable space and, in the vol complex, there's probably opportunities to the upside and probably opportunities at the downside. Vol is probably in quite a healthy, in quite a healthy place. And I think the VOL market

is better for it. Hottest takes. Can be volatility related, can be music related, whatever, whatever you want. After watching Saturday Night Live this week, I've become a Lizzo fan.

All right. That's a hot take. What can you, what does she sing? I think I know one or two of the songs, but yeah. And I didn't really know many of the songs before, but she's an incredibly talented entertainer. She was the host Saturday Night Live, and she was also the artist, and I thought she just crushed it, and I had really never, you know, spent much time around Lizzo before, but there you go. I like it. She's large and in charge. Yeah. Stuart, Vance, got any thoughts? Vance, I'll ask you what's going on with that telescope that's a speaking of large and in charge yeah i got that when i was 15 so nice that's uh had that a long time that was the uh astronomy buff so uh definitely uh uh interested in in uh cosmology and the in the new uh the uh web telescope i'm following that very closely i don't know about that the web

telescope yeah the one that they launched just just getting into position right now the hubble replacement basically yeah uh and this week right there's going to be four of the planets are going to be aligned i think i saw that on twitter the other day um What can you see? Can you see Saturn's rings with that thing? Oh, yeah. No, there was a while back, there was a meteor that hit Jupiter. And it was fun to see because it left this big black splotch I could see in the telescope on Jupiter. Better there than here. Yeah, absolutely.

It would have been a planet killer for the Earth, I think. Right, Jupiter just went, eh. Yeah. All right, you got a hottest take or that was it? That's it. We almost got wiped by a meteor. Stuart, what do you got? I think the process we've been through in launching these new ETFs

has taught me a few things that I think are exciting. And that is the world is becoming, or the average person in the developed world is becoming more sophisticated in managing their own finances, etc. Products are becoming more sophisticated as well. But at the same time, I think the regulators are always perhaps a little bit slower or they're cautious as they should be. But seeing where we are today and the process we've been through with regulators, I'm kind of excited and maybe cautiously optimistic that we are going to be able to see increasingly interesting, useful, exciting, different products. I know you've spoken about the Bitcoin, but, you know, others.

There are so many more and they're going to be able to be formalised and brought to markets and used. Yeah, I mean, that's been my... That's probably the most important thing I've learned in the last couple of years. The regulators are slow to move, but they are moving in the right direction from what I could tell. And do you think that is to the detriment of hedge funds or private advisors of, hey, basically all these strategies are going to morph up the chain into ETFs and publicly available funds? Yeah, you know, I'm a little bit frightened about that argument that says, oh, it's democratizing strategies. Because what really happens is new products bring opportunities.

And I think hedge funds, the opportunity of last year won't be the opportunity of next year. And as products become more complex, or maybe they're not more complex, maybe they're simpler, but they're just more difficult to manage, that brings up opportunities for sophisticated operators like media hedge funds and the groups that are very heavily technology driven to be able to do dynamic hedging or whatever it might be. So I don't know, I don't think that's a problem. I think what happens is maybe the client gets more of what they want. For instance, you're asking, can we have a product that just follows VIX? And we say it's impossible, but there is a world where something like that could be possible. If a lot of things fell into place,

we'd need a lot of technology and a lot of clever development. But it's stuff like that, where you get to a point where it's what the client wants, what the end user really wants, and all the work that goes on behind that that might be complex just happens. And it happens with all the smart people in the background. Opportunity there for people to get paid, opportunity here for people to make money. And I think that's what makes a fantastic growing market. I love it. The flip side of that would people think, oh, it's just financial engineering and Wall Street creating products to enrich themselves and to trade amongst themselves. So I think that's where the promise of democratizing comes in of like, hey, these are available to the everyday

person, the everyday investor with hefty disclaimers. All right. Tell everyone where they can find you. Vance, what's the website and the blog that you put all that good stuff out on? Six Figure Investing. Sixfigureinvesting.com. We'll put links to all this in the show notes. Jim, let them know where they can get you. Well, the easiest way to get me personally is on Twitter, at Fixologist. Unlike Vance, I forgot to change my little screen tag here. Yes, that's nice. But I'm very available on Twitter.

You can also go to Toroso Investments, Toroso Advisors.com. All right. And Stuart, where can they get that prospectus and learn more about the ETFs? AlternativeShares.com. Everything's there. All right. We'll put all that in the show notes. AlternativeShares.com. Everything's there. All right.

We'll put all that in the show notes. Thanks so much, guys. It's been fun. We'll talk to you soon and best of luck with the product. Thank you. Take a good job. Thanks.

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