July 12, 2011

VZZB Is a Sign of the Times

Your shares compete for attention with a dizzying array of choices in securities markets. Money chases what the market gives today. VZZB is the sort of example you can’t make up.

It’s the trading symbol for the iPath Long Enhanced S&P 500 VIX Mid-Term Futures ETN. We saw the circular from Direct Edge, where it began trading today. It’s not some cheese ball confection lofted by off-shore subsidiaries of Boca Raton broker-dealers. It was created by Standard & Poor’s. It’s underwritten by Barclays.

VZZB is an exchange-traded note (ETN), an uncollateralized debt obligation backed by Barclays that trades like a stock, leverages returns, depends on volatility and consists of futures contracts that mimic the supposed future volatility of an index. For gains.

Why should you care, sitting there in the IR chair? Eight of ten days, your stock is moving because somebodies speculated on the divergence of this versus that, or some other bodies tweaked their risk-management schemes to offset increasing implied volatility. Or whatever. It’s all interrelated. If you want to know why your stock behaves the way it does, you must see it in context of how markets work and what behaviors drive supply or demand in your shares.

VZZB’s name says it all. Literally. First, it goes long its components, buying them, not borrowing them and selling them short. Second, it’s “enhanced,” which means it’s using options to outperform the benchmark – for a day. Third, it’s based on the S&P 500. Fourth, it’s really derived from the VIX, the Chicago Board Options Exchange’s wildly popular measure of the implied volatility of the S&P 500 index (VIX options expire the 20th in the middle of earnings). And finally, its components are daily rolling VIX futures contracts four, five, six and seven months out – the “mid-term” – that simulate volatility at various points in the future.

Yet it offers correlated, enhanced returns today. Just a day. And realize this: There is an options chain for this instrument. You can trade puts and calls on this derivative, comprised of derivatives of derivatives, and their implied, leveraged volatility.

Need to help your CFO see why your stock sometimes does the craziest things? Say to him or her: “Look up this ticker, VZZB. Read how it works. Now think about the mindset that invests in volatility as an asset. It’s not fringe behavior. VZZB’s first cousin VXX regularly trades 30 million shares daily.”

Lesson for the observant: Barclays thinks market volatility is back. A Barclays executive said of the launch, “We continue to see investor demand for exposure to volatility…”

And there you have it. Money is buying volatility as an asset class.

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