UBS' suite of new E-Tracs S&P 500 VIX Futures ETNs designed for traders, not investors

By Emma Trincal

New York, Sept. 8 - UBS AG, London Branch's 12 new volatility-based exchange-traded notes are aimed at traders who seek exposure - long or short - to various points along the VIX index futures curve, ranging from one to six months, according to 424B2 filings with the Securities and Exchange Commission.

In the prospectuses, UBS notified prospective buyers that the securities are "designed for traders" and are "not intended to be a buy and hold investment."

UBS priced $10 million of a planned up to $100 million overall issue of 0% E-Tracs 6-Month S&P 500 VIX Futures exchange-traded notes due Sept. 6, 2041 linked to the S&P 500 VIX 6-Month Futures Index Total Return, according to the SEC filing.

The bank priced five other long ETNs linked to the one-, two-, three-, four- and five-month versions of the S&P 500 VIX Futures index for $10 million each.

Separately, the bank offered another series of six ETNs with the same duration but expressing a short view. They give exposure to the inverse performance of the one-, two-, three-, four-, five- and six-month versions of the S&P 500 VIX Futures Index Excess Return.

"Previously, there were limited alternatives for trading different maturities along the VIX futures curve. Investors now have the ability to trade six individual VIX futures maturities, be it long or short, based on their specific view on volatility," Christopher Yeagley, U.S. head of equity structured products, said in a company press release.

A market participant said that other VIX-related products exist in the market, in particular two well-known ETNs from Barclays Bank plc: the iPath S&P 500 VIX Short-Term Futures ETN (symbol VXX) and the iPath S&P 500 VIX Mid-Term Futures ETN (symbol VXZ).

Pick and choose

"But the new UBS E-Tracs are different. It's the first series of VIX ETNs where you can pick your spot on the curve," the market participant said.

The iPath VXX gives investors an average duration of one month, he said, because the underlying VIX short-term index tracks the first and second month of the VIX curve.

For the iPath VXZ ETN, the average duration is five months as the underlying VIX mid-term index rolls continuously from the fourth into the seven month of the volatility forward curve, he explained.

"The two Barclays VIX ETNs give you exposure to only two points of the curve: the one-month and the five-month," the market participant said.

"Here, you have exposure to the entire curve. You can pick your spot and get more control over the type of VIX exposure you want.

"That matters because the VIX curve changes shape all the time."

The UBS products do not offer exposure to the entire volatility curve, however. VIX futures can extend to seven, eight and 10 months.

"But further-out contracts don't trade enough to be able to hedge efficiently," the market participant said.

Contango proof

Besides offering traders more flexibility, one of the objectives of the new suite of VIX products offered by UBS is to help them reduce costs associated with the rolling of futures contracts, according to the market participant.

In particular, the ETNs seek to reduce the cost of rolling contracts on an upward volatility curve, a phenomenon known as contango.

A market is in contango when the prices of near-term contracts are lower than contracts expiring further in the future.

The negative roll yield results from the sale of lower priced near-dated futures contracts to purchase higher priced longer-dated ones.

Contango is a particular problem for volatility traders, according to the prospectus.

"VIX futures have frequently exhibited very high contango in the past, in particular, at the front end of the forward curve," the prospectus said.

"Right now, we're in backwardation, and everything is cheaper," said James White, Excelsior Capital Management, volatility arbitrage hedge fund manager.

Backwardation is the opposite of contango. Short-term contracts that get sold are more expensive than those further out on the forward curve, generating a positive carry.

Hedging the roll

But for the market participant, even in backwardation, investors may incur losses if the investment vehicles they use are strictly designed to counter contango.

"What's really important is to have the flexibility to pick and choose your position on the curve," he said.

"The volatility curve right now forms a V-shape. It's in backwardation for the first, second and third month. And it's in contango for the next three months.

"You want to be long the short end of the curve and short the medium term in order to effectively take advantage of the roll yield."

Without the ability to pick the right contract on the curve, a trader could lose money with the negative roll yield, he said.

"You may think that the VIX is high and you may want to short it. And you could be right. But if you're on the wrong part of the curve, the roll cost could hit your performance significantly.

"If the VIX is low, you may want to be long, but you may also feel that the negative carry associated with being long is too high on the short-term contracts. In that case, you'd want to be able to buy one further out of the curve."

Do-It-Yourself

That is not to say that competing volatility products addressing the contango issue do not exist, the market participant said.

He mentioned Barclays' iPath S&P 500 Dynamic VIX ETN, a volatility product launched last month and designed to reduce the roll cost by dynamically allocating between the VIX short-term index and the VIX mid-term index based on the steepness of the implied volatility curve.

"It's a package strategy, a quantitative package," he said.

"The UBS ETNs are designed for traders who want to implement the strategy themselves. It's the do-it-yourself product."

Comparing the new products with the iPath S&P 500 Dynamic VIX ETN, White seemed to agree: "They're different. One is more for a portfolio manager while the other is for the trader.

"If you want someone else to hedge a huge portfolio for you so you can concentrate on managing your positions, the Dynamic ETN is the way to go.

"But if you want to trade and target a specific month, the other one makes more sense."

Traders are likely to welcome the flexibility of being able to pick the month they want to trade, White noted, although many of them, including him, trade futures directly.

"I think this might be more helpful for a trader than what's out there," he said.

"With that, you might be able to do relative value trades between two months. You could be long one month and short another and take advantage of the way the shape of the curve is changing."

"We use a myriad of volatility products to run our liquidity crisis hedging quantitative model, and this is certainly one that we would look at."

The notes were approved for trading on NYSE Arca under the following symbols:

• "VXAA," "VXBB," "VXCC," "VXDD," "VXEE" and "VXFF" for the long notes; and

• "AAVX," "BBVX," "CCVX," "DDVX," "EEVX" and "FFVX" for the short notes.

UBS Investment Bank is the agent.

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