Bloomberg News

Credit Suisse Relents After VIX Note Whipsaws Investors

March 23, 2012

Credit Suisse said the first round of issuance is aimed at lowering the cost of borrowing shares to the level seen before the Feb. 21 suspension. Photographer: Gianluca Colla/Bloomberg

Credit Suisse said the first round of issuance is aimed at lowering the cost of borrowing shares to the level seen before the Feb. 21 suspension. Photographer: Gianluca Colla/Bloomberg

Credit Suisse Group AG (CSGN), under pressure to restore order in an exchange-traded note tracking U.S. equity volatility, said it will start resupplying the market with shares today after cutting issuance off in February.

Stock will be added to the VelocityShares Daily 2x VIX Short-Term ETN (TVIX), or TVIX. The security, designed to track Chicago Board Options Exchange Volatility Index futures, has whipsawed investors for the past month, climbing 89 percent above its asset value and plunging 29 percent yesterday before Credit Suisse’s announcement. It fell another 30 percent to $7.16 today, extending its retreat since Oct. 3 to 93 percent.

Creating shares in the ETN will help bring the security back in line with its so-called indicative value, the price implied by futures on the CBOE gauge, said Alec Levine, an equity derivatives strategist at Newedge Group SA in New York. Credit Suisse’s first round of share issuance is intended to lower the cost of borrowing the note, a step that may aid short sellers who yesterday helped cut the premium by 66 percent even as owners of the security were burned.

“Lending out shares is an attempt to drive down the premium,” Levine said yesterday in a phone interview. “When your product isn’t trading anywhere near NAV, it’s the market telling you that it’s a broken product.”

Supply, Demand

Trading in the ETN highlights the hazards of exchange- traded securities when disruptions occur in systems designed to balance supply and demand. Because the notes are normally pegged to underlying assets such as stocks, bonds and indexes, sponsors regularly create and redeem shares to offset price distortions caused when investors buy and sell them.

Credit Suisse’s announcement followed a series of actions that caused the ETN to break loose from its reported value before falling yesterday as traders speculated issuance would resume. Credit Suisse halted share creation on Feb. 21 after surging demand for securities tracking volatility swelled the note’s market value to almost $700 million from $162.8 million at the end of 2011.

Katherine Herring, a spokeswoman for Credit Suisse in New York, declined to comment beyond the statement.

Breaking Loose

Yesterday’s drop reflected short selling amid speculation new shares would come into the market after the ETN climbed to record premiums each of the last four days, said Chris Hempstead, director of exchange-traded-fund execution service at WallachBeth Capital LLC.

“It’s not overly surprising given what happened to TVIX during the trading day,” said Dominic Salvino, a specialist on the Chicago Board Options Exchange floor for Group One Trading, the primary market maker for VIX options. “They weren’t forced to do this in a legal sense, but there were some reputational questions for them given the fact that product was performing so poorly and was no longer doing what it was meant to do.”

Volume was 30.2 million shares yesterday, almost 8 times the daily mean since it was created in 2010. The note closed at $14.43 on March 21, or a record 89 percent above its so-called indicative value. The gap narrowed to 30 percent yesterday as the security extended its decline since Oct. 3 to 90 percent.

Latest Controversy

Unhinged trading in the VelocityShares ETN is the latest controversy for exchange-traded funds and notes, which had about $1.2 trillion in assets at the end of February, according to the ETF Industry Association. The European Commission said March 22 that it is examining potential “conflicts of interest” affecting the securities. Laurence D. Fink, chief executive officer of BlackRock Inc. (BLK), warned in November that investors may not understand the assets that back certain funds.

“These volatility ETFs will be closely monitored by the equity derivatives industry, especially when volatility is once again on the rise,” Stuart Rosenthal, chief executive officer of Factor Advisors LLC in New York, said yesterday in a phone interview. “I don’t think we have heard the last word about TVIX creations and for that matter volatility ETFs.”

In yesterday’s announcement three hours after the close of trading in New York, Credit Suisse said the first round of issuance is aimed at lowering the cost of borrowing shares to the level seen before the Feb. 21 suspension. In a short sale, a trader borrows stock and sells it, hoping to profit from a decline by replacing it at lower prices later.

Lending Rates

“Credit Suisse may from time to time issue the ETNs into inventory of its affiliates to make the ETNs available for lending at or about rates that prevailed prior to the temporary suspension of issuances of the ETNs,” the company said.

The number of shares sold short in the Credit Suisse note was 4 million at the end of February, up from less than 1.5 million at the end of 2011, according to data compiled by Bloomberg. The ETN fell 83 percent from Oct. 3 to Feb. 29.

Starting March 28, shares will be issued to authorized market makers. Normally, banks create and redeem ETNs based on the level of demand for the securities. That demand usually doesn’t affect the price since the ETNs track an index.

“Credit Suisse may issue additional ETNs from time to time to be sold solely to authorized market makers,” according to a statement. “Credit Suisse may condition its acceptance of a market maker’s offer to purchase the ETNs on its agreeing to sell to Credit Suisse specified hedging instruments consistent with Credit Suisse’s hedging strategy, including but not limited to swaps.”

Widening Premium

The gap between the security’s price and the value of the index it tracks has widened since Credit Suisse suspended issuance of new shares, causing a supply shortage amid record demand for volatility products that provide a hedge against U.S. equity losses. Short sellers may have accelerated bets against TVIX yesterday on speculation Credit Suisse would resume issuance of more shares, said WallachBeth’s Hempstead.

The VelocityShares ETN aims to produce twice the daily return of the S&P 500 VIX (VIX) Short-Term Futures Index, which tracks a trading strategy involving futures on the CBOE Volatility Index. The VIX, as the CBOE gauge is known, is used as a benchmark measure of U.S. equities derivatives and measures the cost of protection from losses in U.S. stocks. It rose 2.9 percent yesterday.

Credit Suisse’s decision to halt new issuance of TVIX shares preceded a period in which the ETN began moving independently of its underlying assets. The S&P 500 VIX Short- Term Futures Index lost 32 percent between Feb. 21, the day of the suspension, and March 21. That was more than twice the decline in the ETN.

Diverging Prices

The faster decrease in the underlying index contributed to a widening in the premium of the TVIX to its underlying asset. The gap reached a record 36 percent on March 16 and then expanded to 62 percent, 78 percent and 89 percent in the next three days, according to data compiled by Bloomberg.

“Investors should probably remain sidelined until TVIX has returned to its NAV and stabilized there,” Jim Strugger, a derivatives strategist for MKM Partners LLC in Stamford, Connecticut, said yesterday in an e-mail.

To contact the reporter on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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