ProShares Slashes Leverage on Surviving Volatility Products

(Bloomberg) -- After this month’s volatility earthquake blew up a number of exchange-traded products linked to Wall Street’s fear gauge, an issuer of similar funds is trying to prevent any aftershocks.

ProShares Advisors announced changes to its investment objectives to reduce leverage on its Short VIX Short-Term Futures exchange-traded fund (ticker SVXY) and Ultra VIX Short-Term Futures ETF (ticker UVXY). The former, which allowed investors to bet against a rise in volatility, is now aiming to deliver returns equal to one-half the inverse move of the S&P 500 VIX Short-Term Futures Index. Previously, the product had sought to be a perfect mirror image each session.

UVXY, a long volatility product, will attempt to produce returns equal to just one-and-a-half times the underlying index, rather than double the daily move. VIX futures are derivatives on the Cboe Volatility Index, or VIX, a gauge of the S&P 500 Index’s projected one-month price swings.

On Feb. 6, Credit Suisse announced the redemption of a fund similar to SVXY -- the VelocityShares Daily Inverse VIX Short-Term exchange-traded note (ticker XIV) -- after a record one-day spike in the VIX wiped out 90 percent of the value in the inverse product. The popularity of exchange-traded products that allowed investors to wager on enduring market calm exacerbated the downside for U.S. stocks that week, according to some analysts, helping to catalyze a technical correction. 

SVXY -- now the largest exchange-traded product of its kind -- also plunged more than 90 percent in extended trading on Feb. 5, but was not shuttered.

ProShares’s shifts will be effective as of the close of trading on Feb. 27, according to a press release. However, a permanent change of these investment objectives will require regulatory approval, the exchange-traded product provider said.

“Ignoring whether we get inflows or outflows, that should create a bit of buying pressure on VIX futures,” Peter Tchir, head of macro strategy at Academy Securities, said in a note to investors.

The moves may push some holders of the products to rebalance their positions to adjust for the decreased leverage, likely at a cost. They will also have an adverse effect on traders who had bought options on either product.

“Buyers of either calls or puts have paid premia that were based on much higher implied volatility values than will be prevailing post the proposed changes,” said Athanassios Diplas, principal at Diplas Advisors. “Similarly, anyone directly trading these two ETPs, either long or short, whether for hedging or direct investment, will have to adjust their exposures, and incur the associated costs of rebalancing.”

Indeed, many options on these products are coming under heavy selling pressure in trading on Tuesday.

ProShares, through a spokesperson, declined to comment beyond the press release.

An excerpt from the recently-updated prospectus for these products lists increases in margin requirements from exchanges as well as position limits by futures commission merchants and the need to comply with regulatory requirements as potential factors hampering their ability to meet their investment objectives.

“As a result of recent market volatility, the exchange on which VIX futures contracts are traded has increased the margin requirements for such contracts, making those margin requirements significantly higher than those for most other types of futures contracts," it said.

ProShares’s changes should also reduce the chance of an “acceleration event” that could facilitate the closure of either product, if regulatory blessing is received.

“The reduction in leverage reduces the amount these products need to trade daily, and makes SVXY less likely to blow up again,” said Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors. “It’s harder for VIX futures to go up 200 percent in a single day compared to going up 100 percent in a single day.”

ProShares’ alterations come on the heels of similar buffers implemented by REX Shares to shelter their actively managed volatility-linked products -- tickers VMIN and VMAX -- from significant market swings. Those changes, announced on Friday, begin to go into effect on March 7. Owners of those funds will have much more time to react to the shift in methodologies than holders of SVXY and UVXY.

The press release from ProShares noted that the products do not directly track the VIX Index, and are intended for use as trading vehicles rather than long-term holdings.

To contact the reporters on this story: Luke Kawa in New York at lkawa@bloomberg.net, Rachel Evans in New York at revans43@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Joanna Ossinger, Brendan Walsh

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