The Risks of Volatility ETNs

Getting volatility exposure has become easier for investors after the relatively recent introduction of volatility ETNs (exchange-traded notes) and volatility ETFs (exchange-traded funds) and some of these products have enjoyed a surge in popularity.

The recent crisis with TVIX underlines the important differences between ETNs and ETFs, which in turn appear to be at the source of the observed market distortion. An important feature of these products is focused on - namely, that they track constant maturity VIX futures indices rather than the VIX index itself - which has an impact on the quality of the volatility exposure because of the roll-over costs and the lack of cash-and-carry arbitrage relationship.

The TVIX incident opens important, more general questions about the potential hidden risks in seeking exposure to market volatility through volatility ETNs.

This white paper opens this discussion with a general overview of volatility futures and volatility ETNs followed by a short summary of the incident and a general review of issues related to volatility products.