Beware the Black Swan: Short the Market with this ETN

Written by Steve Hercenberg, CFA   
Tuesday, 08 July 2014 05:53

On July 3, 2014, USA Today’s website ran the following screaming headline on its front page, “Dow power! Stock gauge tops 17,000 for 1st time.” 

To me, that was the final straw in a market that has been overbought.  I looked for a suitable way to go short the market and found something that was down the most that day.  Whatever goes down the most on good news is bound to come up the most when the euphoria fades and investors experience “Buyer’s Remorse.”

News organizations often complain that there is no such thing as a good market timer. That may be because they have historically been among the best indicators of a market top or bottom. When the front page of a major newspaper or magazine’s headlines focus on the stock market’s performance, it’s time to run in the opposite direction.  News editors seem to have an uncanny talent for recognizing the peak in euphoria or fear and accentuating that feeling with just the right headline.

Another indicator, the CBOE SKEW index, is near the upper end of its normal range, suggesting that a “black swan” event is increasingly likely during the next 30 days.  So the USA Today headline is merely the catalyst to that condition.

Source: CBOE

As stocks have risen, the CBOE Volatility Index (VIX), also known as the Fear Index, has sunk to multiyear lows and investors seem to be increasingly accustomed to the lack of substantial downward moves. The prospectus of the VelocityShares Daily VIX Short Term Exchange Traded Note [ETN] (TVIX - NYSE - $2.79) warns that the TVIX is only suitable for a very short investment horizon (that is, hours or days). Credit Suisse is the ETN’s issuer.

Credit Suisse’s ETN differs from other types of bonds and notes because ETN returns are based upon the performance of a market index (in this case, the VIX) minus applicable fees.  No period coupon payments are distributed and no principal protections exist. This ETN aims to deliver 200% of the daily return of the CBOE Volatility Index, making its losses or gains even more dramatic.

The prospectus further says that the long term expected value of the ETN is zero. In other words, if TVIX were held as a long term investment, “it is likely that you will lose all or a substantial portion of your investment.”

TVIX and other volatility products are geared to follow VIX futures, not the spot price. Therefore, they can be hurt by contango, or when longer-dated contracts are more expensive than the spot price. This causes the products to lose money on the so-called roll trade.

 

Source: www.StockTA.com

Two recent events—the CBOE SKEW index near the upper end of its normal range and the USA Today Headline on July 3rd about the Dow hitting 17,000—suggest  that a “black swan” event is increasingly likely.  One way to play this event is to buy VelocityShares Daily VIX Short Term ETN (TVIX), which already rose today by 3.72% to $2.79 from $2.65.  Our target price of TVIX is between $2.84 and $3.18 in the next two to four business days.

Disclosure: Goldman Small Cap Research analysts and their clients are long these shares and may elect to sell this ETN within the next 48 hours.

You Might Also Like

Disclaimer:

This Market Monitor blog was prepared for informational purposes only. Goldman Small Cap Research, (a division of Two Triangle Consulting Group, LLC) produces research via two formats: Goldman Select Research, which typically highlights small cap companies, and Goldman Opportunity Research, which features micro cap companies in a sponsored research format. Thus, the Select product reflects the Firm’s internally generated stock ideas while the Opportunity product reflects sponsored research reports. 

Goldman Small Cap Research is not affiliated in any way with Goldman Sachs & Co.

It is important to note that while we may track performance separately, we utilize the same coverage criteria in determining coverage of all stocks in both research formats. Please view the company’s individual disclosures for each engagement, which can be found in each company-specific report. All information contained in this blog, newsletter and in our reports were provided by the Companies or generated from our own due diligence. Our analysts are responsible only to the public, and are paid in advance to eliminate pecuniary interests, retain editorial control, and ensure independence. Analysts are compensated on a per report basis and not on the basis of his/her recommendations. 

The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy. Goldman Small Cap Research did not make an independent investigation or inquiry as to the accuracy of any information provided by the Company, or other firms. Goldman Small Cap Research relied solely upon information provided by the Company through its filings, press releases, presentations, and through its own internal due diligence for accuracy and completeness. Such information and the opinions expressed are subject to change without notice. A Goldman Small Cap Research blog, report, note, or newsletter is not intended as an offering, recommendation, or a solicitation of an offer to buy or sell the securities mentioned or discussed.

This blog does not take into account the investment objectives, financial situation, or particular needs of any particular person. This blog does not provide all information material to an investor’s decision about whether or not to make any investment. Any discussion of risks in this presentation is not a disclosure of all risks or a complete discussion of the risks mentioned. Neither Goldman Small Cap Research, nor its parent, is registered as a securities broker-dealer or an investment adviser with FINRA or with any state securities regulatory authority.

ALL INFORMATION IN THIS BLOG, REPORT OR NEWSLETTER IS PROVIDED “AS IS” WITHOUT WARRANTIES, EXPRESSED OR IMPLIED, OR REPRESENTATIONS OF ANY KIND. TO THE FULLEST EXTENT PERMISSIBLE UNDER APPLICABLE LAW, TWO TRIANGLE CONSULTING GROUP, LLC WILL NOT BE LIABLE FOR THE QUALITY, ACCURACY, COMPLETENESS, RELIABILITY OR TIMELINESS OF THIS   INFORMATION, OR FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL, INCIDENTAL, SPECIAL OR PUNITIVE DAMAGES THAT MAY ARISE OUT OF THE USE OF THIS INFORMATION BY YOU OR ANYONE ELSE (INCLUDING, BUT NOT LIMITED TO, LOST PROFITS, LOSS OF OPPORTUNITIES, TRADING LOSSES, AND DAMAGES THAT MAY RESULT FROM ANY INACCURACY OR INCOMPLETENESS OF THIS INFORMATION). TO THE FULLEST EXTENT PERMITTED BY LAW, TWO TRIANGLE CONSULTING GROUP, LLC WILL NOT BE LIABLE TO YOU OR ANYONE ELSE UNDER ANY TORT, CONTRACT, NEGLIGENCE, STRICT LIABILITY, PRODUCTS LIABILITY, OR OTHER THEORY WITH RESPECT TO THIS PRESENTATION OF INFORMATION.

For more information, visit our Disclaimer: www.goldmanresearch.com
Add comment
  • No comments found