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Volatility-Linked Exchange-Traded Products

Posted by Jack Duval

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Oct 20, 2017 8:04:35 AM

This blog post begins a series exploring volatility-linked exchange-traded products.

VXX LT Chart.gif

The VXX has declined from 11,940 to 34.39 (split adjusted).  Source: Bloomberg.

A recent FINRA Acceptance, Waiver, and Consent (“AWC”), with Wells Fargo and the issuance of FINRA RN 17-32, highlights the risks of volatility-linked exchange-traded products (“ETPs”).  In particular, using them as part of a buy-and-hold strategy is virtually certain to produce losses.

Wells Fargo AWC

On October 16, 2017, FINRA ordered Wells Fargo to pay $3.4 million in restitution to clients who had been recommended volatility-linked exchange-traded products.  FINRA found that Wells Fargo registered representatives had sold the volatility-linked ETPs without fully understanding their risks and features and that the firm had failed to supervise solicited sales of the products.

The FINRA AWC press release stated:[1]

Certain Wells Fargo representatives mistakenly believed that the products could be used as a long-term hedge on their customers’ equity positions in the event of a market downturn.  In fact, volatility-linked ETPs are generally short-term trading products that degrade significantly over time and should not be used as part of a long-term buy-and-hold investment strategy.

FINRA RN 17-32 – Volatility-Linked Exchange Traded Products

The language in the Wells Fargo AWC press release is echoed in FINRA RN 17-32:[2]

… many volatility-linked ETPs are highly likely to lose value over time.  Accordingly, volatility-linked ETPs may be unsuitable for certain retail investors, particularly those who plan to use them as traditional buy-and-hold investments.

Buy-and-Hold

Using a buy-and-hold strategy with volatility-linked products is almost guaranteed to produce losses for investors.  These products are designed to be traded intra-day or over one day holding periods.  Even relatively short-term holding periods of a week or two can be enough to lock in losses.  Longer holding periods can produce catastrophic losses.

How these losses are built into the structure of volatility-linked ETPs will be explored in my next post.

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Notes:

[1]       FINRA News Release; Available at: http://www.finra.org/newsroom/2017/finra-orders-wells-fargo-broker-dealers-pay-34-million-restitution-and-reminds-firms; Accessed October 19, 2017.

[2]       FINRA RN 17-32; Volatility-Linked Exchange-Traded Products; October 2017; Available at: https://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-32.pdf; Accessed October 19, 2017; 1.

For information about securities expert Jack Duval, click here.

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Topics: suitability, supervision, Complex Investments, Complexity Risk, volatility-linked products

    

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