Biggest Vol ETN Breaks: VXX Halted Multiple Times As It Soars In Huge Short Squeeze

March 15, 2022   |   Tags:
Biggest Vol ETN Breaks: VXX Halted Multiple Times As It Soars In Huge Short Squeeze

The Volmageddon event of February 2020 is back, only this time instead of destroying the XIV inverse ETF, it is now targeting the VXX

Yesterday we said that we had a feeling the market would break today, and one look at the VXX volatility-tracking ETN, confirms just that.

As a reminder, on Monday morning Barclays announced - to the shock and dismay of millions of VXX investors on both the long and short side - that it would suspend any further sales from inventory and any further issuances of the VXX VIX Short-Term Futures ETN, claiming that “Barclays does not currently have sufficient issuance capacity to support further sales from inventory and any further issuances of the ETNs.” As some humorously put it, a volatility ETN just broke because of... volatility.

As a result, we also said that it is likely that this product would trade significantly above its asset-based IV price; in fact it would become completely disconnected from its underlying volatility tracker,  it will likely become very difficult to short these products & without shares to short, authorized participants can't do arbitrage operations they typical run to drive price down to IV Price.

And sure enough, that's what is happening this morning, as the VXX has exploded as much as 50% higher even as its underlying - the VIX - is down on the day...

... halted four time in the process (and likely to be halted many more as the day progresses)...

... and margining out countless retail investors who were short the VXX in hopes of collecting pennies in front of a steamroller... which just arrived.

What happens next? Well, if a Chinese tycoon was short the VXX, we are confident that BATS - the market it trades on - would halt the VXX indefinitely and "resolve" the situation. Alas, since only retail investors are getting wiped out, expect nothing to change and while many will sue Barclays, they will collect at most pennies on the dollar.

For those shocked about what is going on with the VXX and what is likely to happen next, here is a primer courtesy of Goldman Sachs:

VIX Positioning: Q&A on VIX Markets Following the VXX Issuance Suspension

Adding to an already-busy week, with derivative markets focused on the FOMC, Ukraine war-driven disruptions, and a large options expiration, the largest VIX ETP (by AUM) has had its share creations turned off. Correspondingly, the VXX has started trading at a premium to its own NAV. In this note, we answer questions about VIX markets in the context of this change.

What happened to the VXX? How does it compare with the TVIX creation halt in 2012?

VXX creations were halted and the ETN is now trading at a premium to NAV. Effective yesterday (14-Mar), new creations of shares of the VXX (iPath Series B VIX Short-Term Futures ETN) were suspended (as were creations of the OIL ETN) until further notice. As long as this suspension remains in place, the creation/redemption mechanism that typically keeps the VXX share price close to its NAV will only work in one direction: one can redeem shares for a cash payment equal to their NAV, setting up the NAV as a floor on the share price, but one can no longer create shares at NAV. This leaves the potential for the share price to exceed its NAV because of the shares' scarcity. The closest analogue[1] to this we have seen in VIX ETP markets was the suspension of TVIX (levered long VIX ETN) creations in 2012. During that period, the TVIX share price traded as high as 90% above NAV before quickly declining down toward its NAV when creations were re-enabled. Yesterday (14-Mar), the VXX traded at a premium to NAV that ranged from 2-11% during the afternoon following the announcement. The TVIX precedent shows that the premium could grow substantially, but it could also quickly return to zero.

Does the VXX creation halt impact VIX futures and options?

Not directly, but their liquidity could be impaired. Any outstanding VXX shares continue to have their usual economics, so there is no direct impact from this on the VIX futures and options curves. Because of the important place of the large and well-known VXX in the VIX ecosystem, one secondary effect we'll be watching is liquidity. A significant proportion of VIX futures liquidity is linked to ETP trading, so a reduction in VXX secondary share trading could lead to reduced liquidity in VIX futures and options. VIX option markets are already large relative to VIX future markets: ahead of today's VIX expiration, the ratio of options open interest to futures open interest is as high as it has been at any recent point outside the height of COVID.

What happens to VXX options with its underlying shares unable to be created?

VXX options could have limited liquidity and may contribute to a volatile premium to NAV. A unique characteristic of the VXX is the large size of its option market relative to the size of the note itself. The VXX has outstanding options referencing six times its share count - more than double the ratio of any ETF or stock except the XRT and HYG. The VXX's options market relies on liquidity in VXX shares to remain liquid. Following yesterday's announcement, VXX option markets traded at wide bid/ask spreads and in small volumes in response to the liquidity challenges presented by the suspension. This Friday's expiration will be a key one to watch for the VXX (as well as for the equity market as a whole), as it is the largest outstanding VXX expiration, with options referencing more than 150% of the VXX's share count set to expire. Should the suspension continue through Friday, we would expect a volatile VXX premium to NAV as we approach the end of the week.

What products can investors substitute for existing VXX shares?

The VIXY ETF is comparable to the VXX ETN. As we discussed when the current VXX was first launched, the VIXY (ProShares VIX Short-Term Futures ETF) has roughly the same underlying economics as the VXX (although it is structured as an exchange traded fund, not as an exchange-traded note), and is continuing to trade close to its NAV. Long VXX holders can sell VXX shares and buy VIXY shares for the same notional, to monetize the VXX premium while keeping the same exposure to VIX futures.

What's the current net position of the VIX ETP market?

Long volatility - but less so than usual. The VIX ETP market has largely consisted of long volatility exposure since the 2018 VIX spike led to the closure of one major short ETP and the de-levering of a second. As volatility has risen over the past four months, investors have taken profits on long VIX positions, leaving the net long position in VIX ETPs close to its smallest net long position since 2018.

Tyler Durden Tue, 03/15/2022 - 10:23


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