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  1. #1
    Join Date
    Nov 2011
    Coral Springs, Florida

    Inverse volatility ETN

    There were several articles on this today and how it played a role in the big drops in the market. I donít quite understand the mechanics of this but it sounds like Credit Susieís put up a note to back shorting certain futures. When volatility was low these positions paid out. When it spiked they had to go out and buy opposite positions to cover their trades so the value of the note didnít go negative and put Credit Suiss on the hook for the deficiency. I have no understanding of the underlying mechanics of this note structure but it essentially sounds like it was margin based and it caused them to try and cover when volatility spiked. Anyone have any knowledge of these products and what they were actually holding or buying?

  3. Stocks/Investments Moderator boneil's Avatar
    Join Date
    Jul 2010
    Aberdeen, MD
    I don't how they work either. But the prospectus clearly states that the product will go to zero if you hold until maturity. It states that if volatility spikes, the note will rapidly lose value and that Credit Suise could terminate it any time that the volatility spiked a certain percent. There were so many ways to lose money on this product and only one perfect scenario where it was profitable. Much like any of the other VIX and VXX products, they're only good for day trading.

    From what I gathered, funds where buying these notes as a way to short volatility and earn a return. Thats about as far as I get with any certainty. I think when volatility spiked, the value of these notes evaporated causing these funds to buy VIX products as a hedge, creating a feedback loop. VIX goes up, that pressures stocks. Also being on margin, these funds would receive margin calls and be forced to sell other assets to cover the margin requirements.

    The feedback loop............volatility spiked = ETN's lost value = hedge with VIX= volatility goes higher= ETN lose more money= margin calls= forced selling of other assets= more volatility= ETN gets terminated= fund loses almost all value of ETN= more margin calls = more selling of other assets= stocks go down rapidly= spook investors who then sell= TV coverage and BS reasons for the sell off= more fear= more selling = buying opportunities.
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