Is Volatility an Asset Class?

[destriero]

Technically Gold does generate cash flows. It provides the real return of money. It's not a cash flow that flows into your bank account each month but those cash flows are embedded in the price of gold and it's one reasons it appreciates or depreciates across time.

Volatility cannot go to zero but XIV certainly can and no doubt will at some point in the future. XIV is nothing more then a complicated swap. It's aim is to replicate the behavior of another derivative. People can call anything whatever they want to.

That can be stated of anything that trades (gold having cash flows). That's what defines a tangible asset. You can't define gold as an asset that provides a return; only that it's convertible, having some innate value related to it's physical properties. There is also an opportunity cost with holding gold (-CF).

In that sense a varswap (and more so, gamma swap(embedded floor)) can be considered an asset. It will always maintain a positive value.

We're really not talking about a leveraged ETF, even though it should always maintain some value (=cash).

 

[Maverick74]

That can be stated of anything that trades (gold having cash flows). That's what defines a tangible asset. You can't define gold as an asset that provides a return; only that it's convertible, having some innate value related to it's physical properties. There is also an opportunity cost with holding gold (-CF).

In that sense a varswap (and more so, gamma swap(embedded floor)) can be considered an asset. It will always maintain a positive value.

We're really not talking about a leveraged ETF, even though it should always maintain some value (=cash).

I understand there is a lot of semantics here. Most of the financial community uses these terms interchangeably. I for one, don't consider gold to be an asset. I get it though that Gold is presented as an asset because it would be impossible to market gold without it. I also get how one can call any ETF an asset. I don't like to mix derivatives (swaps) in with assets since by definition they are terminal. Even though one can roll a swap indefinitely it violates the meaning of the word.

So my argument against volatility being an asset is the fact that it is terminal. Volatility has to be used as a function of time. Again, I get that the volatility ETF's roll indefinitely but one could make the argument that each interval in time is a separate product and the sum of those products creates the return on the ETF. Regardless, we'll call it an unconventional asset at best.

 

[Maverick74]

Back to the OP, I would further offer this up in my defense. Being long VXX or XIV has as much to do with the forward curve of volatility as it does volatility itself. I made the same point on another thread about being long energy etfs. You are really trading the shape of the curve with some spot correlation thrown in. Same with XIV. In fact the reason XIV has drastically under-performed the SPX is because the forward curve was in backwardation. An asset should have definitive properties. So if I'm buying XIV to short vol and vol goes down and I lose money, then I really wasn't short vol, I was short the curve.

 

[Maverick74]

That can be stated of anything that trades (gold having cash flows). That's what defines a tangible asset. You can't define gold as an asset that provides a return; only that it's convertible, having some innate value related to it's physical properties. There is also an opportunity cost with holding gold (-CF).

Agree completely on the opportunity cost of Gold which is why I hate to call it an asset. Although technically in a negative interest rate environment Gold can earn synthetic interest! Although the cost of storing it probably wipes that out.

 

[Sig]

All ETFs are rebalanced daily. That has not stopped the 500 or so that cease to exist today.

A couple of bits of misinformation here. First, ETNs expose you to the credit risk of the issuer, ETFs do not. Second, it is mainly the 2x, 3x, and leveraged ETFs and ETNs the rebalance daily. SPY does not, for example, nor does VXX although internally it's rolling the ratio of the first and second month futures contracts it holds on VIX futures daily.

 

[Maverick74]

A couple of bits of misinformation here. First, ETN expose you to the credit risk of the issuer, ETFs do not. Second, it is mainly the 2x, 3x, and leveraged ETFs and ETNs the rebalance daily. SPY does not, for example, nor does VXX although internally it's rolling the ratio of the first and second month futures contracts it holds on VIX futures daily.

You can read all the ETF risks here:

https://www.hkex.com.hk/eng/prod/secprod/risksetf.htm

 

[Sig]

You can read all the ETF risks here:

https://www.hkex.com.hk/eng/prod/secprod/risksetf.htm

Which says that if the ETF holds swaps there is a counterparty risk in the swap, just like if you or I entered into a swap. Obviously an ETF will be exposed to any counterparty risk of the underlying they hold, but its not inherent to the ETF structure itself like it is with ETNs. It's a minority of ETFs that hold these kind of underlying anyway, typically leveraged and inverse funds, and easy enough to check before you invest. Again, something like VXX only holds VIX futures so you have no more counterparty risk there than if you traded the futures yourself.

 

[Maverick74]

Which says that if the ETF holds swaps there is a counterparty risk in the swap, just like if you or I entered into a swap. Obviously an ETF will be exposed to any counterparty risk of the underlying they hold, but its not inherent to the ETF structure itself like it is with ETNs. It's a minority of ETFs that hold these kind of underlying anyway, typically leveraged and inverse funds, and easy enough to check before you invest. Again, something like VXX only holds VIX futures so you have no more counterparty risk there than if you traded the futures yourself.

You need to read the prospectus, the volatility ETF's play a lot of games with their holdings in order to optimize their returns. It's not black and white sig. FWIW, I knew one of the largest market makers at the CBOE who traded made two sided markets in VIX options that explained some of the risks to me in these vol etf's. It's EXTREMELY hard to replicate because the rolls get pushed by specs ahead of the close. This creates huge distortions in the pricing.

 

[Sig]

You need to read the prospectus, the volatility ETF's play a lot of games with their holdings in order to optimize their returns. It's not black and white sig. FWIW, I knew one of the largest market makers at the CBOE who traded made two sided markets in VIX options that explained some of the risks to me in these vol etf's. It's EXTREMELY hard to replicate because the rolls get pushed by specs ahead of the close. This creates huge distortions in the pricing.

That is something they have to worry about, and it does appear that they suffer a little tracking error on days with big moves probably for exactly the reason you explained.

 

[Amalgam]

Maverick, you seem to be grasping at 100 different straws in defense of your claim that short vol isn't an asset class.