|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.
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.
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.
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