Put This Pair of VIX Products On Your Radar

You know that old saw about no one being able to create a volatility exchange-traded product based on the "cash" CBOE Volatility Index (VIX)? I'm pretty sure I've played a role in that "saw," as I didn't see a way around a few obstacles.

Well, I may get proven wrong. AccuShares is set to list a couple of interesting products on Tuesday: AccuShares Spot CBOE VIX Fund Up Shares (VXUP) and AccuShares Spot CBOE VIX Fund Down Shares (VXDN). This, from their fact sheet:

"AccuShares Spot CBOE VIX Fund Up Class Shares are designed to track the changes in specified measures of price volatility of the S&P 500 Index^® occurring from the prior Distribution Date to the next Distribution Date or a Measuring Period. Because the fund could make period Distribution on a monthly basis, the Funds should be considered a short term investment in volatility and if held for the entire Measurement Period will be a one month investment horizon.

"… Unlike other exchange traded products, the fund will engage principally in cash distributions and potentially paired share distributions to deliver to the shareholders the economic exposure to the funds's underlying index, the CBOE Volatility Index. Such distributions may not represent any income or gains on the fund's eligible assets and may represent a return of shareholder's capital. Each fund will issue its shares in offsetting pairs, where one constituent of the pair is positively linked to the funds's underlying index ("Up Shares") and the other constituent is negatively linked to the fund's underlying index ("Down Shares"). Therefore, the fund will only issue, distribute, maintain and redeem equal quantities of Up and Down shares at all times."

Sounds simple, right? But wait, there's more:

"On any Distribution Date where the VIX closes at 30 or below, the Daily Amount on any day will be 0.15% of the Class Value per Share as of the most recent Distribution Date. The Daily Amount will be subtracted from the Up Share Class Value per share. Under the described circumstances, the daily amount will be added to the Down Share Class Value per Share. Otherwise, the Daily Amount will be zero. The Daily Amount is intended to reflect an attribute of the market for long financial instruments seeking exposure to the expected volatility of the S&P 500 Index implicit to options contracts on the performance of the S&P 500 Index. As reflected in the historical performance of the VIX, the market for such long instruments deteriorates over both long and short term time frames as both S&P 500 Index volatility and the VIX tend to return to a mean level. Under these circumstances, a long position (as represented by the Up Shares) on the VIX will tend to decrease in value over time while a short position (as represented by the Down Shares will tend to increase in value."

OK, it doesn't sound simple. I talked with some folks at AccuShares, and will give this my best stab.

You're essentially betting on the direction of VIX itself -- unlike basically all other derivatives which generally let you bet on the future of VIX. The combo should roughly come out to VIX itself, but it won't be perfect.

First off, there's the 0.15% daily amount that's subtracted from Ups and added to Downs. It's not a randomly chosen number; rather, it's designed to offset the mean-reversion tendencies of VIX.

There's also day-of-week biases involved. Mondays, for example, are typically "up" days for VIX. It averages about a 2%-to-2.5% rally over the long course of time.

Why not just buy VXUP every Friday afternoon? Well, presumably, you won't be able to at VIX "parity" on most Fridays. You will theoretically "overpay" slightly on balance, and it will come out in the wash on the distributions.

So, let's make a couple of assumptions here. One is that the 0.15% number they use for distribution calculations properly accounts for the mean reversion. And the other is that the market will properly price in VIX calendar works. If that's the case, then we're left with two instruments that basically let you speculate on the direction of the VIX.

If that's true, then I think these products are really going to take off. It will prove way less confusing than iPath S&P 500 VIX Short-Term Futures ETN (VXX) and VIX futures. And it fills a niche in that actual VIX is what most players really want to bet on, hedge with, or whatever.

I'd like to see it in action, though, before declaring victory -- or VIX-tory. Perhaps there's a quirk here that I'm missing. We shall see, and soon.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.