21% Surge Shows Why Investors Love a Complex Product

On the very day U.S. regulators announced the latest fine related to complex volatility products, market gyrations showed just why these controversial strategies are in hot demand on Wall Street.

As stocks sank Monday and the Cboe Volatility Index spiked, the ProShares Ultra VIX Short-Term Futures ETF (ticker UVXY) jumped 21% -- trouncing almost every U.S. exchange-traded fund out there.

It underscores the appeal of these complicated trading vehicles, which have been embraced by everyone from old-school investors seeking protection to daytraders wielding rocketship emojis.

With 1.5 times leverage, products like UVXY are designed to post outsized gains when stocks slump -- as they did on Monday, spurred by fears over the coronavirus delta variant.

Yet apart from these rare money-minting opportunities, many investors see their allocations to such products eroded through relentless carrying costs that slowly bleed long bets. And in an extreme selloff, some short-volatility instruments can and have been decimated.

The U.S. Securities and Exchange Commission cited the former in announcing that UBS Group AG had agreed to pay $8.1 million to settle allegations over compliance failures in marketing a popular exchange-traded note tied to volatility.

In a statement on Monday, UBS said it proactively removed the ETN from its platform before being contacted by the SEC. “After fully cooperating with the SEC, UBS is pleased to have resolved this matter,” the firm said.

The product in question wasn’t UVXY, and in fact was a note rather than fund -- that means it is structured more like a debt instrument, rather than investing directly in the underlying asset. Still, they share some of the same characteristics -- including the costs for anyone holding long-term.

In the UBS settlement, the SEC said some financial advisers had a flawed understanding of the appropriate use of the instrument. As a result it was held in hundreds of accounts for more than a year.

That’s almost a sure way to lose money, because absent a considerable volatility spike, the contracts tracked by these notes mechanistically lose value as time passes -- a decline known as the “rolldown.”

In the wake of the “Volmaggedon” episode of February 2018, regulators have been laser-focused on volatility products, which can be difficult to understand and even exacerbate stock-market swings. As a result, several planned instruments sit in regulatory limbo.

21% Surge Shows Why Investors Love a Complex Product

That hasn’t dimmed their appeal however, which was once again illustrated on Monday.

Among U.S. exchange-traded products with more than $500 million, UVXY was the best performer by more than 7 percentage points, with the iPath Series B S&P 500 VIX Short-Term Futures ETN -- effectively a new version of the note in the UBS settlement -- in second place.

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