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Out-of-whack Credit Suisse security puzzles volatility traders

[September 16, 2019] By Saqib Iqbal Ahmed

NEW YORK (Reuters) - A small, unexplained aberration in a highly specialized corner of the vast U.S. equity and derivatives market is causing a buzz among traders already on edge about a potential market pullback.

An exchange-traded note issued by Credit Suisse Group AG, commonly known as TVIX, that tracks stock market volatility is trading at a premium of about 3% over what it should be priced based on its underlying securities. That premium is about twice the average for the past year.

While TVIX is not considered a bellwether for the stock market, at a time when investors are jittery about the health of the equities market any unexplained price moves serves to unnerve investors.

(Graphic: TVIX - trading at a premium, https://fingfx.thomsonreuters.com/
gfx/mkt/12/6111/6042/Pasted%20Image.jpg)

In the past, the TVIX premium has risen when stocks have fallen. So a persistent premium when equity markets are relatively strong has stumped specialized traders of volatility.

Normally, traders do not pay much heed to how the TVIX is behaving. But these are not usual times. The S&P 500 is flirting with all-time highs, despite signs that U.S. President Donald Trump's trade war with China and Britain’s planned exit from the European Union may be pushing the world into a recession.

To many traders it is only a matter of time before markets fall, and they want to see it coming before others do.

The TVIX is of the same genre as an ETN called XIV, which went bust in a matter of days in February 2018 after a spike in its premium. Holders of that security saw nearly $2 billion of their money go poof, a disappearing act that some traders say exacerbated a massive correction in the U.S. stock market. Both ETNs are issued by the Swiss bank Credit Suisse.

"Obviously XIV is very fresh in our minds since its demise,” said Ben Pinkleton, an independent trader in Greensboro, North Carolina, who owns 2,500 shares of TVIX.

Although XIV and TVIX have differences, Pinkleton added, "You never want to be in that situation as a trader. So when questions are raised about TVIX you're going to be a little restless."

THEORETICAL PRICE

Formally known as VelocityShares Daily 2x VIX Short-Term ETN, TVIX tracks twice the returns of the S&P 500 VIX Short-Term Futures Index, a measure of market volatility.

Its tendency to rise in price when stocks slip has made it a darling of traders looking for a way to guard against a slump in equity prices. It is now the largest VIX-linked exchange traded product, with about $850 million in assets. It is heavily traded, with some 42 million shares changing hands daily, according to Refinitiv data.

As its issuer, Credit Suisse publishes a theoretical price for the TVIX through the day so traders know what its value would be if it were doing a perfect job of tracking the S&P VIX futures index.

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Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., September 12, 2019. REUTERS/Brendan McDermid

(Graphic: TVIX - market value, https://fingfx.thomsonreuters.com/
gfx/mkt/12/6110/6041/Pasted%20Image.jpg)

TECHNICAL PROBLEM?

The current aberration in the TVIX could be a technical problem that gets resolved without any incident, traders and analysts said.

One explanation of why the premium may have appeared lies in how Credit Suisse controls the supply of new shares, traders and analysts said.

When the TVIX trades at a premium to its theoretical value, large financial institutions short it. When the issuer releases new shares at the theoretical value, the financial institutions settle the short position and pocket the profit.

On occasion, however, the premium can balloon, especially if the issuer ceases to create new shares. In 2012, for example, the TVIX premium rose to 90% after Credit Suisse temporarily suspended further issuances of TVIX shares due to internal limits on the size of ETNs.

"The fact that a significant premium in TVIX has persisted implies that they (Credit Suisse) have not been issuing enough shares for whatever reason," said Matt Thompson, managing partner at Chicago-based investment adviser Thompson Capital Management, which specializing in investments using VIX instruments.

YELLOW FLAG

Seth Golden, chief market strategist for the advisory Finom Group, said Credit Suisse may not want to issue new shares if it is more expensive for it to do so. The bank buys derivatives such as swaps to hedge risks it takes on by creating new shares, which represent unsecured debt, and their price may have gone up, Golden said.

The price of the swaps, however, is not widely known.

Credit Suisse has not explained the premium so far. It declined to comment to Reuters on the trading price for TVIX or whether there was any change to the process of share creation.

Analysts and traders said that while Credit Suisse may not be issuing new shares, they did not know for sure and that has put already nervous traders more on edge.

"In general, a premium or a discount between the indicative value and the trading value is a yellow flag," said Vance Harwood, who runs the alternative investment website Six Figure Investing and is a consultant focused on volatility-linked products.

"It's an indication that you should look closer to see if there is a market disruption or this is just the variations in the cost of borrowing or cost of creating shares," he said.

(Reporting by Saqib Iqbal Ahmed; Editing by Paritosh Bansal and Leslie Adler)

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