On Tuesday next week we will see a new pair of VIX ETFs hit the market: VXUP and VXDN from AccuShares Management. Unlike existing VIX ETPs which move based on VIX futures, these new ETFs will move based on the price of spot VIX.
However, the operation of these funds is not as straight forward as one might expect. I've gone through the 150 page prospectus and have briefly outlined what you can expect from these new products (the full prospectus is available here for those interested in additional details).
Fund Objectives
Basic Fund Operation
Distributions
A primary concept of the funds are periodic Distributions. These will be predominantly done in cash for the first six months, but will be in the form of issuing paired shares of VXUP and VXDN thereafter (depending on the fund's liquidity). Here are the Distribution types:
Any distributions of cash, or cash and shares, will reduce your exposure and opportunity for gains arising from changes in the Fund’s Underlying Index in subsequent periods. You will need to rebalance/buy additional shares to maintain desired exposure. This concept will be made clear in the example below.
Price Movement Examples:
VXUP will often face a headwind caused by the "Daily Amount" of 0.15%. The table below summarizes the value of VXUP and VXDN for various VIX scenarios after a Measuring Period. Note that when the VIX is +4.5%, the gains in VXUP are offset by the losses from the Daily Amount (since 0.15*30 = 4.5).
In the next table, the VIX is assumed to have moved up 10% from 20 to 22 over 30 days. At the Distribution Date, the result is a 5.5% increase for VXUP and a 5.5% decrease for VXDN based on the combination of the VIX movement and the $0.0375 Daily Amount.
Note that the Fund will distribute a cash amount of $2,750.00 per 1,000 shares of VXUP. The new per share value for each fund is then set at $23.6250.
If instead there is a 10% decrease in VIX from 20 to 18 over 30 days we will have the following:
Here, VXUP will return -14.5% and VXDN will return a total of +14.5% based on both change in the VIX and the effects of the Daily Amount.
It is critical to note that after each favorable movement in a security held, your exposure is reduced due to distributions. In the case of issuing paired shares in lieu of cash, your exposure is still reduced and you would need to sell/buy shares as necessary to maintain a desired exposure.
It is worth highlighting that the Daily Amount only exists when VIX is below 30. When above 30 it is zero so the VXUP headwind goes away.
Supply & Demand and the Arbitrage Mechanism for creation/redemption of share units
The facts outlined above cover the basics of these new funds. There are many other additional details and nuances covered in the prospectus which I encourage you to read through if you are considering trading these products.
This article was originally published on Trading Volatility on May 15, 2015.