Dynamic Shares, an affiliate of Chicago-based trading house ARB Trading, has introduced its first ETF: the Dynamic Short Short-Term Volatility Futures ETF (WEIX US).
The ETF adopts a dynamic approach to selling volatility futures.
Listed on NYSE Arca, the fund provides inverse exposure to short-term US equity market volatility.
Selling volatility is an investment strategy that, historically, has been primarily deployed by institutional investors. It typically involves the selling of futures contracts referenced to the CBOE Volatility Index, known colloquially as the VIX.
The VIX measures the market’s expectation for volatility in US large-cap equities over the next 30 days. It is derived from implied volatility in near-term S&P 500 options contracts.
While there are several existing ETFs that provide inverse volatility exposure, these funds typically come with significant risks, making them unsuitable for most retail investors.
These risks recently came to the fore during the February 2018 spike in US equity market volatility, a period that has subsequently been named ‘Volmageddon’. The period saw massive losses across inverse-volatility strategies and the implosion of at least one inverse-volatility ETF, while many products that did survive subsequently reduced their inverse volatility exposure in an attempt to limit extreme losses during future volatility spikes. The $290 million ProShares VIX Short-Term Futures ETF (VIXY US), currently the largest inverse-volatility ETF on the market, now delivers 50% inverse exposure to near-term VIX futures on a daily basis, down from 100% pre-Volmageddon.
Despite this more cautious approach, Dynamic Shares argues that the existing line-up of inverse volatility funds is still inefficient due to their static approach regardless of the current VIX environment. The firm, therefore, set out to design a product that provides superior risk management by dynamically adjusting its level of inverse VIX exposure.
The ETF’s investment philosophy is centered around the historical tendency of the VIX to follow a pattern of mean reversion.
The fund’s baseline for inverse exposure to front-month VIX futures is relatively low (from 5% to 15%). This exposure is then recalibrated daily using a proprietary algorithm based on two inputs – the daily change in the front-month VIX futures contract, and changes to the shape of the VIX futures curve across all maturities.
Generally, following the mean reversion hypothesis, the ETF will gradually increase its inverse exposure to front-month VIX futures as the VIX rises, up to a maximum of 50% inverse exposure. Similarly, the fund will typically reduce inverse exposure back towards its baseline as the VIX falls.
The ETF also utilizes an additional risk management overlay (what Dynamic Shares refers to as a “stress mode trigger”) that seeks to protect investors from extreme spikes in volatility when the price of VIX futures could increase significantly.
The stress mode is triggered when two conditions are met – near-term VIX futures prices begin breaking away from their average trend, and the price of the front-month VIX futures contract rises above the following month. Both situations imply the market is predicting heightened volatility in the short term. When the stress mode is triggered, the ETF may reduce its inverse VIX exposure to zero.
It should be noted, however, that the stress mode trigger will not protect investors against losses incurred as a result of a significant, one-day increase in the price of VIX futures due to the stress mode recalibration commencing after an increase in volatility at the end of the trading day.
According to Dynamic Shares, the fund’s responsive approach to volatility investing makes it suitable as a potential long-term holding that could serve to enhance portfolio diversification.
The ETF comes with an expense ratio of 1.85%.
Amnon Baazov, co-Founder and Chief Investment Officer of Dynamic Shares, said: “With equity valuations near all-time highs and bond yields near all-time lows, we believe attractive returns will be difficult to achieve in the coming years. Using the skills and technologies we have honed in our proprietary trading firm, we aim to efficiently harvest the volatility premium that exists in the marketplace using a mathematical and systematic approach to shorting volatility.”
Mark Downing, Chief Product Officer of Dynamic Shares, added: “With a current market environment reminiscent of the peaks of the Roaring ’20s and the Dot-Com bubbles, we believe investors are looking for investment alternatives with low correlation to equity indices that also have the potential for attractive returns and capital preservation in highly volatile markets. We created WEIX in an attempt to provide just that solution – a sophisticated and measured approach to selling VIX futures in the accessible ETF wrapper.”
Investors interested in inverse-volatility ETFs may also wish to consider the Simplify Volatility Premium ETF (SVOL US). While this fund maintains a static 25% daily inverse exposure to VIX futures, it also dedicates a modest option budget to purchasing deep out-the-money call options on the VIX, effectively protecting the fund against extreme spikes in volatility. Launched in May 2021, SVOL has accumulated $90m in assets and comes with an expense ratio of 0.50%.