The Risks of Volatility ETNs: A Recent Incident and Underlying Issues

Abstract

Getting a volatility exposure has become easier for investors after the relatively recent introduction of volatility ETNs (exchange-traded notes) and volatility ETFs (exchange-traded funds), and some of these products have enjoyed a surge in popularity. In this article, the authors use the recent crisis with TVIX—a volatility ETN—to underline important differences between ETNs and ETFs that appear to be at the source of the observed market distortion. The authors emphasize an important feature of these products—that they track constant maturity VIX futures indexes rather than the VIX index itself, which has an impact on the quality of the volatility exposure because of the roll-over costs and the lack of cash-and-carry-arbitrage relationship.