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There's a potentially important new ETF launching next Tuesday, May 19th, which allows investors to invest in the well-known CBOE Volatility Index.
Will it do a better job of tracking the VIX than other ETF and ETN products? The answer is likely yes, but there are some wrinkles.
The CBOE Volatility Index measures the intensity of put and call buying for the S&P 500 for a 30-day period and is often referred to as the "fear index."
The new Volatility ETF is attracting more attention than usual because the brains behind it is Robert Whaley, the man who invented the VIX.
His company, AccuShares, will float two different VIX ETFs: 1) the Spot VIX Up Class (VXUP), which seeks to track the VIX over a one-month period, and 2) the AccuShares Spot VIX Down Class (VXDN), which seeks to track the inverse performance of the VIX over a one-month period.
Why an inverse ETF? It has to do with how the ETF is structured.
Other ETFs exist to track spot indices—including commodites like oil—but they buy future contracts in their respective sectors. When the contracts expire, the next contract has to be bought, which greatly increases the cost of investing, since most future contracts are in contango, that is, the cost of the contracts further out are more expensive.
So you are usually buying high and selling low.
That creates tracking errors from the index. In other words, most investors find the investment they bought does not track the spot index they want to follow.
AccuShares is trying a different approach with this VIX product, and with other spot indices they will be launching in the near future. They hold cash and cash equivalents. Each ETF has an "up" asset class and a "down" asset class. Assets are swapped back and forth, depending on the increase or decrease in the spot price.
On the 15th of every month, everything is recalibrated. So you are essentially making a bet on where the VIX might be in the middle of the month.
With that said, there are a couple important details:
1) This is not free. There is a management fee of about 90 basis points a year.
2) There is a monthly distribution. Because this is cash, any accrued interest is paid out to shareholders (they park the cash in Treasurys). While it does create tax issues, it is treated as ordinary dividend income and will be reported on a 1099 form.
3) if you own the Long VIX there is a "tail risk insurance premium" that is paid the Short VIX of 15 basis points a day.
Why? Whaley pointed out to me that the VIX is not like a stock. That's because everyone knows that at some point the VIX will spike up—in some cases dramatically—in response to some event. It will also come back down again.
This has a very simple implication: at some point, you are going to make money if you buy the VIX, because we all know it is going to go up at some time. You just have to hold it, and voila! At some point it will go up, and you will make money.
What this means is that shorts are disadvantaged by definition. Who is going to sell you this product knowing that you are guaranteed to make money at some point, and they are guaranteed to lose money?
No one. So longs have to compensate the shorts for the risk of being short.
Why 15 basis points? Whaley tells me that is the point at which his team felt that market participants were willing to make a market in the products.
So, does it track the VIX? Let's take a look at an example.
On a daily basis, it seems to be pretty close. For example, from May 4th to May 5th, the VIX moved 11.4 percent, from 12.85 to 14.31.
If you deduct the 15 basis point fee, you have a gain of 11.25 percent, minus a management fee of roughly 0.0025 percent, the one-day cost of that annual 90 basis point fee, which gets you to 11.2475 percent.
VIX up 11.4 percent, you get 11.2475 percent. Not bad. Pretty close.
But that is for one day. The tracking error gets larger if you hold it for longer periods.
Suppose you invest $1,000 in the Up ETF (VXUP) on the 15th of the month and one month later the VIX is up 10 percent, so the value of the fund is $1,100.
Here's what you will have: 1) the $100 from a 10% gain, 2) whatever interest rate you get from short-term Treasuries (a few pennies), because the fund parks the cash here, 3) less the daily 15 basis point fee, which over thirty days would amount to $45, 4) minus the management fee of one-twelfth of 90 basis points, which is roughly $0.77, let's call it $1.
So you'd have a gain of roughly $100-$45-$1 = $54 or a roughly 5.4 percent gain.
That is not the same as a 10 percent gain, BUT you would get something that is directionally correct.
Bottom line: you'd have an index that tracks the VIX, but how closely depends on how long you hold it. You are paying a significant fee for the option-like privilege.
That sounds like an awful lot of fees, but when you compare how much is lost by the cost of carrying futures in the alternative products that use VIX futures, it may be worth it.
What does all this mean? You can definitely make money if you have a strong hunch that volatility is going to spike in some period in the not-too-distant future.
But because of the costs and distributions, this is not something you would want to hold for any length of time. It's the kind of trade you would want to make a quick directional bet on.
Whaley agrees that this is for short-term trading bets, and in case you don't get this point, it's spelled out in the prospectus: "Investors who do not intend to actively manage and monitor their Fund investments at least as frequently as each distribution date should not buy shares of the Funds."
Whaley says he has plans to launch many other target spot indices—largely for commodity indices in oil, natural gas, agriculture, and metals.
These products should not need to have the "tail risk insurance premium" the VIX products have, and so they should more closely track the underlying indices, even over longer periods of time. That would be significant.
Is investing in volatility ever going to be an asset class that you can buy along with stocks, bonds, commodities? Tom Lydon, editor and publisher of ETF Trends, told me it might become an asset class if there was something available to buy that correlated to the VIX.
This may or may not be that instrument, but I am doubtful volatility will become a big asset class. What I do believe is that it can be a very useful tool to manage short-term risk, and that, as Whaley pointed out to me, has great value when markets change on a dime on geopolitical and macroeconomic events.
A fake filing related to a takeover of Avon has highlighted several issues for regulators.
Avon was having a perfectly normal day, trading around $6.60 at 11:35 a.m., ET, when the stock shot up to almost $6.97, triggering a volatility trading halt.
These "volatility trading halts" are single-stock circuit breakers that were created after the 2010 "flash crash" to control volatile trading in stocks. Simply put, it stops trading in a stock if it moves more than 5 percent in a five- minute period. The stock halts for five minutes everywhere (not just on the NYSE), then reopens, but if there are still huge imbalances, it can be halted for up to another five minutes.
Some firm calling itself PTG Capital had filed an offer to buy Avon for an exorbitant price. Given that it was at a 20-year low, the move immediately attracted attention.
The stock reopened, and immediately shot up to almost $8, triggering another trading halt.
By then, traders on the floor were noticing that the filing contained numerous typos, and no one had ever heard of them. There were rumors floating around that they didn't even exist.
My colleague Brian Sullivan called both the attorney's listed for the firm and the company; both went into very odd sounding voice mail.
When it reopened, the stock went in the other direction, from roughly $7.98 to $7.60, triggering a third and final trading halt.
CNBC reached out to Avon and they told us "it has not received any offer or other communication from such an entity ... and has not been able to confirm that such an entity exists."
In other words, it was a hoax.
There are two problems here:
1) how on earth did a phony filing get into the SEC's Edgar database? The trading community assumes filings made there are accurate and reliable, because—everyone assumes—they are supposed to be vetted by the SEC.
2) the NYSE (and other exchanges) should have the power to halt a stock when there is unusual and unexplainable trading activity, but it does not.
A company has the power to halt trading in its stock if it has "news pending," but that did not happen. In fact, the NYSE was unable to get in touch with the company during the halts, despite many attempts.
In the past, NYSE floor officials were able to halt stocks for an "order imbalance," that is, a huge order of buy stocks with no sell orders, or vice-versa.
That went away several years ago. Instead, the "volatility trading halts" were what stopped the trading. That's what happened—three times.
It might be easier and more logical if exchange officials merely had the power to halt stocks that are trading strangely for inexplicable reasons. This is an issue for the regulators.
At 2 p.m., ET, the stock was still trading up roughly 6 percent. Why? Because the big price moves and huge volume (more than five times normal) generated heavier than usual volume and volatility, even after everyone realized the story was a hoax.
How is that possible? Because heavy trading begets more trading. The heavy volume and higher volatility allowed traders to step in and make small amounts of money trading the stock, which corresponds to that cynical old trader saw, it doesn't matter if the story is right or wrong, as long as you're on the right side of the trade.
What happened to retail? It looks sluggish, despite a lot of noise.
April retail sales come in unchanged, below expectations of a 0.2 percent gain.
Remember, this is not a first quarter number. This is second quarter, and retail sales are a significant component of GDP. Look for downward revisions for second quarter GDP.
Bond yields dropped—though later recovered—and the dollar index dropped to its lowest level since February.
Retail Sales are now flat or down four of the last five months.
The pull of Easter spending into March was likely an issue, but what happened to the lower gasoline prices that were supposed to save consumers money?
John Tomlinson at ITG Investment Research notes that gas prices began increasing at the beginning of February, and are up about 25 percent since then. Consumers who live paycheck to paycheck don't notice that gas prices are down year over year, but they do notice how they fluctuate week over week.
Or maybe they were drinking more. Sales at restaurants and bars increased 0.7 percent.
They're definitely ordering online. Receipts at online stores increased 0.8 percent.
If you think the short end of the curve is controlled primarily by the Federal Reserve, the long end is traditionally controlled by expectations about growth and inflation. If you assume modest GDP growth of, say, 2.5 percent, and inflation remaining below the 2 percent Fed target, does that conform with this recent rise in bond yields, with the 10-year at 2.31 percent?
If you believe the market is moving on fundamentals, then the sudden rise seems to imply that the market is pricing in either stronger growth or stronger inflation.
The problem is, it's not clear that the rise is due to fundamental issues in the United States.
There's clearly some influence from European bonds. The yield spread has been decreasing between U.S. and German bonds, creating a relative value spread. Simply put, when the spread narrows there is less value in owning the higher-yielding U.S. debt, so you sell U.S. debt.
There's also liquidity issues: We don't know what the influence is from less inventory available for trade, which may be creating gaps.
There's also some interesting issues for insurers and pension companies. Remember, they need to match their assets with their liabilities.
The higher the yield gets, the more their liability increases, and they need access to assets that can offset those liabilities. If they're unable to access those assets, their pensions become underfunded. So a rise in yields without a corresponding rise in assets creates a problem.
At any rate, the focus will shift to the roughly $64 billion of Treasury debt this week in the form of 3-, 10- and 30-year auctions.
Earnings: Second quarter will not be the same as the first, but analysts don't believe it.
I've been noting the slowly improving picture for earnings in the first quarter, but it's the second quarter outlook that matters.
As we entered the earnings season a month ago, earnings for the S&P 500 were expected to be DOWN roughly 5 percent from the same period last year.
As of Monday, earnings are expected to be UP fractionally, according to Factset.
That's a roughly 6 percentage point turnaround, and it is a big number. It's well-known that analysts usually overshoot on earnings, and usually on the upside, but typically analysts overshoot by roughly 3 percentage points as we enter earnings season, not 6.
This time they overestimated in the wrong direction, and instead of three percentage points too OPTIMISTIC, they were six percentage points too PESSIMISTIC.
What happened? Analysts saw the huge decline in commodity prices at the end of 2014 and drastically took down earnings for the most commodity-sensitive sectors: energy, materials, and industrials.
But they made a mistake: they assumed commodity prices were in for a long-term decline, but that's not what happened. Major commodities like oil, copper and aluminum began bottoming in January.
Commodities in Q2
Crude oil (WTI) up 24%
Nickel up 15%
Copper up 6%
Aluminum up 4%
As a result, stocks in those three sectors have risen off their lows. Indeed, Energy and Materials are the two biggest sector gainers in the S&P 500 in the second quarter, up 5.2 percent and 3.7 percent, respectively.
Unfortunately, it looks like analysts have the same attitude they did in the second quarter as they did in the first—they are still too pessimistic and too slow to change their numbers.
Earnings are expected to be down 4.3 percent for the second quarter, and are still coming down. On March 31, they were expected to be down 2.2 percent.
OK, that's only a spread of two percentage points, but they are still coming down, even as stocks have recovered from the earnings worries.
Two lessons here:
1) When it comes to who you should be watching, watch the markets over the analysts.
2) It's true that low commodity prices—like low oil—are good for consumers, but higher commodity prices—wthin reason—are good for stocks overall, though certain sectors (airlines) will be negatively impacted.
With the S&P 500 only a point or two from another historic closing high, the question has been, "What would decisively bring us into new high territory?"
It's not that no one believes we can do it. Over the weekend, two market watchers reiterated their basically optimistic view of stocks. Dan Greenhaus at BTIG said the bias for stocks remains to the upside, while Jeff Saut at Raymond James went even further, saying an upside breakout is coming.
Short-term, a lot may depend on what retailers are saying, because they begin reporting this week. Macy's and JC Penney report on Wednesday, followed by Nordstrom and Kohl's on Thursday and Gap next week.
With the exception of Macy's, retailers have been big laggards this quarter:
Q1 retail stock performance (as of Friday's close)
No one is expecting too much, since what guidance that has been provided has been very cautious.
We also get April retail sales this week. The hope is that the pickup that began in March will continue into April, but it was an ugly winter:
The bottom line: Consumers seem to be spending money on cars, student loans, electronics and dining—but not on retail in general.
The hope among bulls is that because retailers have been such laggards, any positive indications from them about a pickup in April sales will pop the stocks. (Remember, their quarter ends in April, not March.)
Friday saw a strong, broad rally that for the most part has held its early-morning gains. Four stocks advanced for every one declining; eight of the 10 S&P 500 sectors rose more than 1 percent.
Why are bond yields down today and not continuing the rally we saw all week? It goes back to that "Goldilocks" idea, just strong enough to indicate that the job market is back on track, but not so strong to scare anyone into thinking that June is the likely month for the Fed to hike rates.
The lower yields were a help to homebuilders, building materials and REITs—all interest-rate sensitive sectors—though that outperformance faded a bit late in the day.
Here's the conundrum for stocks: the Fed can't easily raise rates because of the weak economy.
But the markets can't break out because of the weak economy.
And that's where we are: back up to the top end of the trading range. We've been here before, with no follow through.
For bears and skeptics in general, it's hard to see a major breakout with stretched valuations, mediocre earnings and the Fed raising rates.
One thing's for sure: the key level everyone is watching is roughly 2,120 on the S&P 500. We closed at 2,116. Short again!
S&P futures moved almost 10 points on the April nonfarm payroll report of 223,000, essentially in line with expectations of 224,000. March revised down 39,000 to 85,000. Broad rally at the open.
Bottom line: March weakness is being ignored, and at least there is no "bleed-through" into the second quarter. June is still unlikely for a rate-hike, but September is more and more likely.
Not only did U.S. stocks move up, all the European bourses moved up on that news as well. The dollar bounced around but is generally weaker.
1) It's been an ugly week for China, but overnight the Shenzhen index was up 4 percent and Shanghai rose 2 percent, as Beijing approved a trading link between the Shenzhen and Hong Kong stock exchange, which would add to the already existing link between the Shanghai and Hong Kong exchanges. It should be in operation by the fourth quarter of this year, according to Barron's. After a slow start in November, the existing Shanghai-Hong Kong link has seen explosive traffic in recent months.
2) I wrote Thursday that the IPO market has hit a rough patch, with many biotech IPOs trading below their initial prices. Today, the slowdown is confirmed: Six IPOs scheduled to price didn't make it public this week, including Commercial Credit, International Market Centers and a raft of biotech/pharmaceuticals:
What's going on? You could blame it on the old standby, "market conditions," but the biotech sector play, which has been so strong for the last year, appears to have had its run, at least for the moment.
One bright spot is that Southern restaurant chain Bojangles made it in, pricing at $19. That's a victory, considering original price talk was $15-$17, then raised to $18-$19.
But that isn't the only warning sign. What's bugging me is the biotech IPO market has just gone to hell this week.
I know, that's a strong claim, but look what has happened with these biotechs, all of which went public this week:
1) OpGen, was set to price in a range from $8-$10, priced at $6 (!), now trading at $4.66.
2) CoLucid (CLCD), set to priced in a range of $13-$15, priced at $10 (!), trading at $8.19.
3) Adaptimmune Therapeutics, set to price in a range of $15-$17, priced at $17 and was trading below $16 this morning before rising in the late afternoon.
4) Collegium Pharma, price talk $12-$14, priced at $12, trading at $12.30
5) HTG Molecular Diagnostics , price talk $13-$15, priced at $14, was trading at $13 this morning before rising later in the afternoon.
6) TYR PHarma priced at the midpoint of $14, now trading at $14.61. But a measly 4 percent rise is practically a shrug.
Ugh. The market is saying that it doesn't want a lot of biotechs at the moment.
Wait, it gets worse. Several others were scheduled to price earlier this week and have not yet made it to market: Gelesis (GLSS) and MultiVir (MVIR). Not sure what will happen with them.
Another—KLOX Technologies (KLOX)—was postponed.
Another, Anterios (ANTE), is scheduled to price tonight, seeking to raise 3.9 million shares at $12-$14.
Is this the start of a new phase of investor skittishness? They do seem to be resisting the urge to buy companies that don't have much in the way of revenues and earnings, but I doubt this is the start of another biotech debacle. For the most part, these companies have real science and real big pharma companies behind them.
Unfortunately, the owners may have inflated ideas of the valuation.
Come to think of it, the IPO market in general isn't as hot as it used to be. The Renaissance Capital IPO ETF (IPO), a basket of the last 60 or so IPOs, hit an historic high at the end of April and is down about 4 percent since then.
This all makes me long for a simple, understandable IPO, and we are getting it: Bojangles (BOJA), the southern restaurant chain, is pricing tonight, and there is interest: originally pricing between $15 and $17, now $18-$19.
And we have Fitbit also announcing it will price on the NYSE.
Late last night, the Securities and Exchange Commission approved a long-awaited program to trade small-cap stocks (less than $3 billion in market capitalization) in increments of five cents, rather than a penny.
This plan has been under discussion for years. Ever since trading increments went from sixteenths ($0.0625) to a penny in 2000, traders have argued that small-cap stocks have seen less trading. Widening the spread, some say, will allow more incentive to trade small-cap stocks and may also increase analyst coverage, drawing more attention to stocks that would otherwise languish.
Others doubt it will make much of a difference.
The plan as approved divides the small-cap universe into three separate test groups, with 400 stocks in each group.
The first test group has minimum five-cent trading increment, with no exceptions. The second group would have some exceptions, such as allowing orders to be executed at the midpoint between buy and sell orders.
The third group is the most controversial: It will require that off-exchange trading platforms (dark pools, mostly) provide price improvement compared with the current best orders in the market. This "trade-at" rule is designed to prevent orders from going to dark pools and has been championed by exchanges, which are the obvious beneficiaries.
A fourth control group of stocks would see no change to their quoting and trading.
The program will last two years.
Goldman Sachs and Morgan Stanley would cease to exist under "living wills" drawn up to show how banks would handle bankruptcy in a crisis.
Oil's free fall could continue, with U.S. crude futures breaking $50 in the near future.
Last year saw a big shift in institutional investors in Greece, as it changed from developed to emerging market, according to eVestment.