WOW, Proshares reducing leverage on two volatility funds

[Robert Morse]

I think OCC should have treated it as a corporate action since the effect in IV is logical and substantial. It's the options that are most affected by this....

How would the OCC have made the adjustment under OCC rules? They can't have one option based on the old math and one under the new one, as the old one is no longer calculated and the OCC does not have a rules for this type of adjustment, as far as I know. Looks like another class action to come.

 

[JSOP]

Yeah... options holders are screwed... IV dropped 50% in SVXY and 25% on UVXY...

I think OCC should have treated it as a corporate action since the effect in IV is logical and substantial. It's the options that are most affected by this....

No that changing of the leverage rate would not qualify as a corporate action. This is an inherent change in the characteristic of the security that affected its value. A corporate action is an action that is specifically undertaken by the corporation that fundamentally changed the security itself that it became a different security. OCC is only able to adjust the option when it's completely changed to a different one.

The changing of the leverage rate is just something that changed in the characteristic of the ETF that in turn changed the value of ETF in the market in the same way when a company announced a change in the dividend payout amount or the voting rights of a stock and that changed the value of that stock. Anything that's characteristic or a feature of a security that gets changed can result in a value of that security in the market. And that is part of the risk of holding or investing in that security, same as investing in any security. I feel bad for option holders but that class action lawsuit won't win.

 

[JackRab]

How would the OCC have made the adjustment under OCC rules? They can't have one option based on the old math and one under the new one, as the old one is no longer calculated and the OCC does not have a rules for this type of adjustment, as far as I know. Looks like another class action to come.

No I don't think they have any rules regarding this specifically... but they could justify a change.

If the underlying's computation is changed in a material way, like with these ETF... than I think they should have altered the options specs.
It's pretty obvious that halving the leverage from 1 to 0.5 changes the volatility by 50%. So I think there is definitely a reason to do it. And for all to keep fair, they should have...

The entire idea behind these ETF is to get the volatility... they just halved it by altering the underlying prospectus.

So, not sure who would sue who... ETF holders shouldn't because the only thing that changed for them is the actual exposure, which is easily offset by doubling the position on closing just before the change comes in effect (in SVXY case, +33% in UVXY). The options holders can't do that, as soon as the proposal to change gets out... that's when you should lower the implied vols by 50% and 25% resp. That economic loss is instant and due to this corporate action style adjustment.

So, if I were an options holder, I would go for the OCC... but probably not going to be getting you anywhere.

 

[JackRab]

No that changing of the leverage rate would not qualify as a corporate action. This is an inherent change in the characteristic of the security that affected its value. A corporate action is an action that is specifically undertaken by the corporation that fundamentally changed the security itself that it became a different security. .

The main point of trading the UVXY and SVXY is to trade the VIX on a 2:1 or 1:1 ratio... if the issuer suddenly changes the ratio to 1.5:1 and 0.5:1... that changes the characteristic of the security and maybe not affect the current value, but definitely the future values.

So IMO it most definitely has changed fundamentally, since it's the leverage that most people get interested in.... which causes the added volatility... which affects the pricing of the options.

It probably doesn't qualify as such within the current OCC rules... but it should and I would be surprised if they don't add some ruling based on this.
The OCC is there to supervise and clear fair and orderly trading... this wasn't it.

 

[newwurldmn]

The main point of trading the UVXY and SVXY is to trade the VIX on a 2:1 or 1:1 ratio... if the issuer suddenly changes the ratio to 1.5:1 and 0.5:1... that changes the characteristic of the security and maybe not affect the current value, but definitely the future values.

So IMO it most definitely has changed fundamentally, since it's the leverage that most people get interested in.... which causes the added volatility... which affects the pricing of the options.

It probably doesn't qualify as such within the current OCC rules... but it should and I would be surprised if they don't add some ruling based on this.
The OCC is there to supervise and clear fair and orderly trading... this wasn't it.

It's equivalent to a business changing its operations.

A corporate action from the OCC perspective is designed to ensure a holder of a synthetic has got the similar economics as a shareholder of the cash. This is so that hedging can stay consistent for the most part.

 

[JSOP]

The main point of trading the UVXY and SVXY is to trade the VIX on a 2:1 or 1:1 ratio... if the issuer suddenly changes the ratio to 1.5:1 and 0.5:1... that changes the characteristic of the security and maybe not affect the current value, but definitely the future values.

So IMO it most definitely has changed fundamentally, since it's the leverage that most people get interested in.... which causes the added volatility... which affects the pricing of the options.

It probably doesn't qualify as such within the current OCC rules... but it should and I would be surprised if they don't add some ruling based on this.
The OCC is there to supervise and clear fair and orderly trading... this wasn't it.

The changing in the price of the options is the result of market reaction to something inherent that has changed in the security itself. OCC only steps in when something arbitrary or artificial has caused the INCORRECT pricing or dealing of the options. In this case, the option price was priced correctly according to the change in the leverage rate. OCC would NOT step in and nor would it add any additional rules about it. I am sure this is not the first time that an option's price has changed dramatically to reflect a fundamental change in the underlying itself.

 

[JackRab]

It's equivalent to a business changing its operations.

A corporate action from the OCC perspective is designed to ensure a holder of a synthetic has got the similar economics as a shareholder of the cash. This is so that hedging can stay consistent for the most part.

No, I disagree... it alters the security. It's an ETF, a derived product... it's not a share in a company we're talking about...

 

[JackRab]

The changing in the price of the options is the result of market reaction to something inherent that has changed in the security itself. OCC only steps in when something arbitrary or artificial has caused the INCORRECT pricing or dealing of the options. In this case, the option price was priced correctly according to the change in the leverage rate. OCC would NOT step in and nor would it add any additional rules about it. I am sure this is not the first time that an option's price has changed dramatically to reflect a fundamental change in the underlying itself.

No, again I disagree... the OCC changes options specs not due to incorrect pricing, but because of certain events, corporate actions that change the underlying security/stock in a way that can't be foreseen by investors in options.

A normal dividend is to be expected, so dividends are not a corporate action that will cause the OCC to change the options specs. Splits, special dividends, rights issues... they are corporate actions that change options specs.

Options are always priced according to the specs... so there's never really any incorrect pricing.

IMO, this change in the underlying specifics should have been a reason to change the options specs. It wasn't in the OCC rules... but I think they should have gone ahead with it. Just my opinion... I didn't have any options in those ETF's.

 

[newwurldmn]

No, I disagree... it alters the security. It's an ETF, a derived product... it's not a share in a company we're talking about...

Still the arbitrage between the cash and the synthetic isn’t violated.

 

[JSOP]

A normal dividend is to be expected, so dividends are not a corporate action that will cause the OCC to change the options specs. Splits, special dividends, rights issues... they are corporate actions that change options specs.

You are right. Changing of the dividend rate of a dividend, just like changing of leverage rate is NOT a corporate action so NO OCC adjustments is required. Options were priced correctly according to the change in leverage rate.

I am glad you convinced yourself on this one.