Quote:
Originally Posted by ibavly
That's not correct, nothing to do with a % of NAV. When it falls 80% Day over Day they have the option of closing it down and paying 100% of NAV (which will likely be greater than zero barring a major VIX spike tomorrow).
Worth noting that its still just an option they have available to them, its not required. People are treating XIV like it is dead, and while the probability is high its not a sure thing yet. I'm sure they are a lot of conferences going on in CS right now about future revenue value and reputation risk.
It also depends on their current risk profile. In some cases closing the fund could actually be bad for them. Given the $4 NAV its also possible that they have already gotten out of most of the ETN positions.
Will be an interesting day tomorrow.
Thanks for the correction, just learning about this process as well. This is from the article I posted: If CS Does Prepay, What Do I Receive?"
An important misconception we have come across as it relates to Event Acceleration is that if the ETN experiences early termination, its holders will end up with nothing. Here's what the prospectus says (PDF pg. 2, originally stated in bold):
..upon acceleration
you will receive a cash payment in an amount (the "Accelerated Redemption Amount") equal to the Closing Indicative Value on the Accelerated Valuation Date.
To illustrate, if Credit Suisse decides to accelerate XIV upon it falling below 20% of the previous day's Closing Indicative Value, but then the futures fall back down before the end of the day, they will be obligated to pay holders whatever the underlying index is worth as of that day's close (the accelerated valuation date). This amount could very well be zero, but it could also be significantly higher.
While We're At It…
It is worth mentioning that because the ETN is a long instrument, the holder's max loss exposure is just the value of the ETN. That is to say that if the ETN is trading at $100/share, for instance, it is impossible for the holder to lose more than that amount. More on this below as it relates to potential risk to CS as the sponsor.
Obligatory Acceleration
Freeze in the Underlying:
Potential acceleration events other than dropping below 20% of the previous day's closing indicative value center around legislation that might hinder their ability to manage the ETNs, such as if the government " makes it illegal to hold, acquire or dispose of the applicable underlying futures (Prospectus PDF pg. 53)." While we do not find this eventuality to be likely, we do harken back to Fall 2008 when it became illegal to short the banks, or the Summer of 2015 where China put severe restrictions on shorting stocks or even taking new short futures positions.
As we mentioned previously, Credit Suisse is not obligated to take the positions in VIX futures that the performance of XIV or any of the other ETNs in the series are based on. In other words, we cannot be certain as to what Credit Suisse's overall volatility positioning looks like, and in the event of a VIX spike, acceleration could certainly be to their benefit.
Placement Breaks
A different form of potential type of acceleration has to do with a contract between Credit Suisse and Janus Henderson Distributors who assists them with the placement of VIX related ETNs. Here's how it is worded in the prospectus (pdf pg 54):
..if JHD exercises their right to cause an early acceleration due to a termination of our agreement with them in certain circumstances, we will be obligated to accelerate all of the outstanding ETNs within ten (10) calendar days of such termination.
Again, the likelihood of this happening is probably not significant, but it is worth knowing that XIV could be accelerated even if Credit Suisse has no desire to do so.
CS Product Exposure and Current Profit Profile
Risk Exposure
We assert that the decision as to whether or not to accelerate would boil down to whether CS sees the continuation of XIV as having favorable risk/reward tradeoff. As pointed out in the Forbes article we mentioned earlier, if XIV's underlying index looks like it is going to decrease more than 100% in a single day, " having a trigger mechanism that leaves them plenty of buffer (20%) to unwind their hedges is prudent risk management."
As discussed above, the maximum drawdown for a holder of XIV amounts to a 'mere' 100%; it is certainly not impossible that the index to which XIV is inversely tied could increase by more than 100%: CS may or may not carry net short exposure to F1 and F2 VIX futures. In other words, if the value of the implied underlying futures should double, XIV would go to zero and any losses beyond that would theoretically be shouldered solely by Credit Suisse.
In reality, CS's overall net volatility exposure is considerably more complex than what is indicated by XIV's underlying index. In furtherance of this notion, CS manages several ETNs in the volatility space (nine total for US equity), most of them long. This means that the sponsor very well may consider some of these products to be naturally offsetting in terms of the company's short-term exposures.
While it is safe to assume that CS has hedges in place to protect themselves in the event of a VIX spike, we maintain that their decision to accelerate could go either way on the sole dimension of risk.
Profit Profile
To assess the likelihood of CS exercising its prepayment right, it is imperative to put the hefty revenues associated with this note in perspective.
Considering the amount of money Credit Suisse is earning from XIV, we do not think they are very likely to arbitrarily exercise acceleration in the near future. XIV's AUM as of October 9th was just shy of one billion:
Source: VelocitySharesETNs
With an annualized cost of 1.35%, if the market AUM stayed constant (not likely), the ETN would bring in approximately $13.5 million per year in revenue.
Clearly, Credit Suisse would not just arbitrarily elect to rid themselves of such an income stream for what might amount to a severe but temporary headache. As such, we believe that the decision to accelerate would occur only under a market environment of great and extended distress, where clean and liquid hedging was rendered next-to-impossible.
Conclusion
No matter the exact cause of acceleration, the key point to keep in mind is that XIV carries no guarantee of longevity. Whether holders of the product are given an advance notice of one day, five days, or ten days, determining the best way to handle acceleration on your instrument of choice probably is not something you would want to be doing on the spot.
Therefore: if you regularly employ XIV in your trading or investment tool kit, it is worth your while to consider (and document) how you will handle acceleration. Our suggestions include looking into other volatility related products such as SVXY, as well as evaluating strategies such as shorting VXX or taking positions in VIX futures. We emphasize here that the convexity profile of shorting VXX is quite different from going long XIV."
