This post will discuss how ZIVB works, including how it trades, how its value is established, what it tracks, tax treatment, termination risk, likely liquidity, and performance simulations.
Volatility Shares’ new -1x Short Mid-Term VIX Futures ETF (ticker: ZIVB) started trading Wednesday, April 19th. After a gap of over two years, volatility traders have access to a -1X leveraged mid-term volatility ETF. ZIVB’s Prospectus is located on the Volatility Shares website.
Before we get into the specifics of how ZIVB works, I’m disclosing that I am an Advisory Board member and Senior Consultant with Invest In Vol LLC. The sponsor of ZIVB, SVIX, and UVIX, Volatility Shares LLC, is an affiliate company of Invest In Vol LLC. I have a small, minority share in Invest in Vol and Volatility Shares. I do not hold management, executive, or operational roles in either of these firms nor do I give recommendations or investment advice to their clients. My analysis of these funds and their associated indexes is my own, is not investment advice, and is based on publicly-available information.
Just about anyone who’s looked at a multi-year chart for a long volatility fund like Barclays’ VXZ or ProShares’ VIXM has thought about taking the short side of that trade. VelocityShares’ ZIVB is an Exchange Traded Fund (ETF) that allows you to hold a short volatility position while avoiding some of the issues associated with a direct short position in VXZ or VIXM. Because ZIVB is tied to VIX futures with at least 4 months until expiration its daily percentage moves are considerably smaller than the moves of funds (e.g., VXX, UVXY, UVIX) that are tied to shorter-term, more volatile VIX futures.
What’s Different About ZIVB?
The biggest difference between ZIVB and ZIV, the previous -1X leveraged short term volatility fund is that ZIVB is structured as an ETF, and is compliant with the Investment Company Act of 1940 regulations (’40 Act). As a result, ZIVB’s tax treatment likely will be the same as regular stocks, with Form 1099 reporting of gains and losses, rather than the K-1 reporting that ZIV used. I am not a tax advisor, but my understanding is that ZIVB held in non-taxable accounts such as IRAs will not require tax reporting.
Unlike ZIV, ZIVB will probably have options available soon after its introduction, something that never happened with ZIV because of its structure as a leveraged Exchange Traded Note (ETN). Volatility Shares’ ability to structure ZIVB as a ’40 act fund will make ZIVB an investment option for investors that are limited to only holding securities that are compliant with the ’40 Act.
While not likely to impact ZIVB significantly, Volatility Shares, when doing their end-of-day rebalancing, limits their trade volume to no more than 10% of the market volume in any 15-minute period of continuous market trading, including after-hours trading. Rebalancing is an operational process (described later in this post), used by leveraged funds to achieve their target leverage. Since ZIVB’s likely percentage moves are significantly smaller than the short term VIX volatility funds the mid-term VIX futures volume associated with its rebalancing operations will likely be small. The net effect of this rebalancing restriction is to structurally prioritize the smooth functioning of the market over the precise tracking of ZIVB/SVIX/UVIX share prices to their underlying indexes.
How is ZIVB’s Value Established?
- Ultimately ZIVB value is tied to the daily resetting inverse of an index (S&P VIX MedTerm Futures Inverse Daily Index) that specifies a hypothetical portfolio of VIX futures with 4 through 7 months until expiration. Every day the index specifies a new mix of VIX futures in that portfolio. On any given day one-third of ZIVB’s assets are allocated to VIX futures with 5 months till expiration, another third is allocated to 6th-month futures, and the final third is split between 4th and 7th-month futures. This mix of VIX futures gives ZIVB the approximate performance of a VIX future with 153 days until expiration.
- The excess return index ZIVB tracks, SPVXMPI, is maintained by the S&P Dow Jones Indices. The net asset value of ZIVB is published every 15 seconds during market hours as the “intraday indicative” (IV) value. Yahoo Finance publishes this quote using the ^ZIVB-IV ticker. Because ZIVB’s day-end value is set by the settlement prices of VIX futures the closing IV value of ZIV is established at the NYSE 4:00 PM ET close.
- One potential wrinkle in ZIVB’s precise tracking of the SPVXMPI index is a side effect of how ZIVB is structured. Since ’40 Act funds can’t directly hold futures or derivatives, all of ZIVB’s VIX futures buy/sells will be done in a wholly-owned Caymen subsidiary, specifically, -1x Short VIX Mid-Term Futures ETF Cayman Ltd. The ’40 Act rules require that holdings in subsidiaries such as these be less than 25% of ZIVB’s overall investment at the end of its fiscal quarters, so ZIVB may need to lower its investment level in its Caymen subsidiary before the end of each quarter, which might affect tracking to its index.
- Volatility Shares’ short term funds, UVIX and SVIX use the SHORTVOL and LONGVOL indexes that incorporate measures to smooth out the end-of-day rolling/rebalancing volumes in the front two VIX futures contracts. Volatility Shares did not create a SHORTVOL-style mid-term index for ZIVB, probably because the end-of-day market stresses on the mid-term VIX futures are much lower than the short term futures, and do not justify the expense of creating a new index. Operationally, Volatility Shares will include ZIVB’s rebalancing needs into their overall commitment to constitute no more than 10% of the market volume in any 15-minute period of continuous market trading, including after-hours trading.
How does ZIVB trade?
- ZIVB trades like a stock. It can be bought, sold, or sold short any time the market is open, as well as pre-market and after-market periods.
- ZIVB’s shares can be split or reverse split—but unlike long volatility funds such as VXX (with 7 splits since inception), splits of ZIVB will be an infrequent event.
- ZIVB is tradable in most IRAs/Roth IRAs, although your broker will likely require you to electronically sign a waiver that documents various risks. Shorting of any security is not allowed in an IRA.
How is ZIVB’s price established?
- The bid and ask prices of ZIVB should typically be close to its Indicative Value (IV) price. The IV price is the per-share value of the fund’s underlying assets minus fees and operational costs. During periods of heavy selling/demand, the bid/ask prices might start moving away from the IV price. If ZIVB’s prices start diverging from its IV value during regular market hours then market makers and wholesalers called “Authorized Participants” (APs) will likely intervene by buying or selling shares of ZIVB. If ZIVB is trading enough below its IV price they will start buying large blocks of ZIVB—which tends to drive the price up. If it’s trading high, they will short ZIVB. The APs have an agreement with VolatiltyShares that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep ZIVB’s tracking in good shape. For more information on these behind-the-scenes arbitrage processes see Why Arbitrage is Essential For Exchange Traded Products.
- ZIVB will likely register gains during rising market periods but will experience drawdowns when markets are in turmoil. The chart below shows a simulation of ZIVB from March 25, 2004, using index values. The simulation assumes ZIVB has an annual fee of 1.35% and an estimated 0.63% per year in additional fixed and operational costs. A free copy of this simulation including ZIVB’s IV values, and index similar to SPVXMPI is available here, ZIVB backtest.
- ZIVB’s potential for big drawdowns is shown in this simulation with a 30% drawdown in the February 2018 Volmageddon and 62% in March 2020 during the Covid crash.
- ZIVB seeks investment results before fees and other expenses that correspond to the daily moves of the SPVXMPI index. This index is maintained by the S&P and its values are published during market hours. SPVXMPIT values can be found on the S&P Dow Jones Index website and Yahoo Finance as ^SPVXMPI. The Net Asset Value/Indicative Value (NAV/IV) values for ZIVB will be published by Yahoo Finance as ^ZIVB-IV. I offer a free spreadsheet with simulated close IV values for ZIVB since March 2004.
What is ZIVB’s Market Strategy?
- The term structure of VIX futures is contango about 80% of the time, with prices increasing with additional time to expiration. Unless there is significant turmoil in the market the futures usually decay significantly in value over time when they are in this configuration. Since ZIVB is short VIX futures, it’s positioned to benefit from that decay.
- This situation sounds like a short seller’s dream, but VIX futures occasionally go on an upward tear, punishing those that are short volatility.
- ZIVB does not behave like a static short position. It attempts to track the daily percentage moves of the SPVXMPIT index. To accomplish this strategy ZIVB must rebalance its investments near the end of each day. For a detailed example of what this rebalancing looks like see “How do Leveraged and Inverse ETFs Work?”
- There are some very good reasons for this rebalancing strategy, for example, a static short position can only produce at most a 100% gain and the leverage of a static short is rarely -1X (for more on this see “Ten Questions About Short Selling”). ZIVB, on the other hand, should be able to deliver a move very close to the percentage daily move of SPVXMPIT on an ongoing basis.
- Detractors of the daily rebalancing approach correctly note that ZIVB and funds like it often suffer from volatility drag. If a long volatility fund like VIXM moves around and then ends up in the same place ZIVB will lose value, whereas a static short of VIXM would not. However, as I discussed in “Is Shorting UVIX, UVXY or VXX the Perfect Trade?”, static short positions have other problems.
- While volatility drag often reduces performance, daily resetting funds like ZIVB don’t always underperform. If VIX futures are trending down, they can deliver better than -1X cumulative performance. For more on this phenomenon see “Sometimes Leveraged Funds Outperform.”
- In backtest simulations, ZIVB has median moves of -0.21X compared to the CBOE’s VIX index. If the VIX moves up 10% you can expect ZIVB on average to move down 2.1%. However, this relationship is not cast in stone. At times ZIVB and VIX will even move in the same direction.
Can ZIVB Terminate?
ZIVB doesn’t have a percentage decline trigger as ZIV did, but it can terminate, as can any Exchange-Traded Product. In its prospectus (on approximately page 71) it says:
The Trust or any series or class thereof may be terminated at any time by the Board of Trustees upon written notice to the shareholders
How Good is ZIVB’s Liquidity?
- Initially, ZIVB’s bid/ask spreads will likely be a few cents, with relatively low average daily volumes. As I discuss in Evaluating the Liquidity of Low Volume Exchange Traded Funds, the key liquidity source for ETPs is the liquidity of the underlying security, which in ZIVB’s case are the liquid fourth through seventh-month VIX futures.
What are the advantages of ZIVB relative to inverse short term volatility funds like SVIX or SVXY?
- The 4th through 7th-month VIX futures that ZIVB uses are in contango more often than the short term funds. Contango tends to drive up the price of ZIVB, because when in contango the futures held tend to drop in value every day.
- Volatility drag, ever present in leveraged ETPs, will be significantly lower in ZIVB compared to the short term funds. Volatility drag in leveraged funds is proportional to the volatility squared of the underlying index. In this case, ZIVB’s volatility will be about 2% daily, instead of the 4% daily of SHORTVOL, therefore its average volatility drag will be 1/4th of SVIX.
- More investigation is needed, but it appears that the SPVXMPI index may often lag the short term indexes by a day in strongly reacting to equity downturns. If true that might offer precious time to exit a ZIVB position before significant damage is done.
- ZIVB is a product intended for sophisticated investors and should not be viewed as a “buy and hold” investment.
- ZIVB will experience drawdowns when volatility spikes.
- In my opinion, ZIVB is best used when the VIX Futures’ term structure is in contango and its investors have a plan to exit their position when the market is nervous (e.g., a VIX/VIX3M ratio greater than 0.95) or protective options strategies are in place to handle a volatility spike.
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