ETF Expert Corner

RexShares CEO Greg King Explains Inverse VIX ETF, Discusses ETF Education

July 25th, 2017 by ETF Store Staff

Greg King, Founder & CEO of Rex Shares, spotlights one of the top performing ETFs year-to-date, the Rex VolMaxx Short VIX Weekly Futures Strategy ETF (VMIN), and discusses the need for education around VIX-related ETFs.



Transcript

You can listen to our interview with Greg King by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the REX VolMAXX Short VIX Weekly Futures Strategy ETF, ticker symbol VMIN. This is the top performing non-leveraged ETF so far this year. It's up more than 110%. This ETF provides short exposure to short-term VIX futures. It's effectively trying to move inverse the VIX, or volatility index. REX Shares also offers a long version of this ETF, which we'll touch on as well. Joining us via phone from Westport, Connecticut to discuss these ETFs is Greg King, Founder and CEO of REX Shares. Greg, great to have you back on the program.

Greg King: Hey, Nate. Great to be here again. Thanks for having me on.

Nate Geraci: Greg, before we get to these ETFs, for listeners who may be unfamiliar with the VIX, can you walk us through some of the basics? What is the VIX designed to do and how good of a gauge is this on investor fear?

Greg King: Yeah, great question. The VIX Index has been around for a little while now. It was sponsored by the CBOE, the Options Exchange. The goal of the VIX really is to measure the price of implied volatility across the series of S&P 500 options. That's a mouthful, I know, but the idea generally is that you can back out of options prices a measure of volatility, basically what the market is expecting the volatility of the S&P 500 to be over the next month. The VIX actually looks at one month's S&P options.

Nate Geraci: Okay, so let's talk about the REX Short VIX ETF, again ticker symbol VMIN. Explain for us the basic construction and what this ETF is seeking to capture.

Greg King: Sure. A couple things to understand, first, I think is helpful about the VIX itself - the reason it's important is people look to it as a measure of, as we've been all taught by CNBC, the fear in the market, the fear index – it’s been really low recently. The reason also that investors like to watch it is because it's inversely correlated. A lot of people look to the VIX as a potential hedging instrument when markets go down. Our product, VMIN, there's a couple of building blocks to put in place there to get to the point where you understand what's happening with VMIN, as we call it. It is a short strategy on the VIX. The only way to invest in the VIX really is through VIX futures contracts. The VIX itself is a computed index. It's almost a theoretical number that's hard to track in a real time basis. About 10 years ago, the CBOE launched futures contracts on the VIX, similar to S&P futures contracts.

Now, if you take a step back and think about what the VIX is - and right now actually as a matter of fact, they may be all time intraday lows on the VIX, literally today. I was looking at it before I jumped on. It was 9.15, I think it hit, which is very, very low implied volatility. That's because essentially the market realized volatility is extremely low as well, even as low as 3% or 4% lately. The VIX is a number that has an asymmetric return profile. What that means is essentially if you take, especially from where we are now of VIX at 9, it can't go a whole heck of a lot lower because there's going to be some movement in the market, but we've seen in go to 80 and 89, I think, is the all-time high. You really have a situation where the return profile's asymmetric.

What that means is that holding the long position in something with that type of a characteristic is going to have a cost to it. Conversely, during normal times, having a short position is going to have an accrual benefit to it. Essentially, you have to pay to stay long, and you typically get paid to be short. The VMIN fund is the next evolution of VIX products, we think. It's the first pure ETF, registered investment company ETF, to track a short-term VIX futures strategy. Really what we try and do is just have a portfolio of VIX futures that are continually held short and benefit the fund from the accrual that takes place by holding that position continuously. Now, the flip side of that is when VIX does spike, this type of fund sells off with the idea being that there are some investors who want to have this exposure whether it's for a short or a longer period of time. That's what's driven our year to date returns.

Nate Geraci: Greg, this ETF is actively managed, correct? There's a manager attempting to optimize how VIX futures are bought and rolled.

Greg King: That's right, they have discretion over that, but it does have the stated goal of being continuously in that short position. The active management is present, but it's not to be confused with taking defensive positions. You will not see this fund, for example, go to cash if the VIX is having a large move. It has a mandate to hold that short position.

Nate Geraci: As you mentioned, this ETF is structured as an open-ended fund. It's a 1940 Act Investment Company wrapper. What's the benefit of that to investors?

Greg King: It's essentially the mutual fund regime, which came about after the '20s and '30s and the market rout. Congress put together the Investment Company Act of 1940. What that means is you do have a fiduciary, you do have a portfolio manager operating the fund. There are other ETFs out there that don't have that structure. They may be commodity pools that are regulated in a different way. They may be actually not funds at all, exchange-traded notes, which are bank notes issued by large financial institutions but do carry credit risk. We felt that creating this as a 40 Act fund, so to speak, was just the best gold standard type of investment vehicle for investors.

Nate Geraci: Greg, I mentioned the performance of VMIN at the top of our conversation. What's interesting is that while the VIX has remained historically low, it obviously hasn't decreased 110%. You began to touch on this a bit earlier, but can you explain in more detail for our listeners, how has this ETF generated the types of returns we've seen recently given where the VIX is?

Greg King: That's a fantastic question. I think there's a lot of investor education that's possible here. We call it a short VIX futures strategy, and so you would tend to think, "Well, the thing needs to go down." If you're shorting something, it needs to go down in order to make money. Of course, that's true, and as VIX falls, generally this strategy would profit. But it also tends to, under normal circumstances, have what I called earlier an accrual type of benefit as well. The reason for that is because futures contract has an expiry. Our fund tends to hold a portfolio of futures that expire, on average, in about three weeks. We're actually making trades every day. To simplify, every three weeks we have to roll that position.

The way that the futures curve tends to look is similar to a yield curve where you have a steepness going out longer along the curve. For example, I printed it out just leading up to this call, in VIX, you have spot VIX in the 9s, as I mentioned, and December, which is just a few months out, VIX is 14 and change, the VIX futures contract in December is 14 and change. If you imagine that that curve kept the same shape and you were short that contract at 14, and then you arrived in December and it had fallen down to 9, that would be a huge move where actually what happened was everything stayed the same. It's just time progressed. What happens within the fund is as time progresses, that steepness accrues to the benefit of people who are rolling short positions. Conversely, long investors are paying for that steepness.

We happen to be at the very, very front end of the curve. That's a position we've taken on purpose because that is where typically the steepest part of the yield curve, or the VIX futures curve I should say, is. We're trying to actually be in a spot where we can maximize that benefit.

Nate Geraci: Just to restate in layman's terms for listeners, the bottom line is volatility could remain flat or perhaps even increase slightly, but because of the shape of the VIX futures market, you can actually see an increase in an inverse VIX ETF because of that roll yield.

Greg King: Right. Essentially, the market always, when volatility is at these lows, I shouldn't say always, but the market generally tends to expect it to increase out in the future. But that doesn't necessarily happen, and so those positions can accrue that value. There's a lot of inner workings here and mechanics to understand, but that is generally the profile of this position.

Nate Geraci: Our guest today is Greg King, Founder and CEO of REX Shares. Greg, REX Shares also offers a long version of this strategy, the REX VolMAXX Long VIX Weekly Futures Strategy ETF, ticker symbol VMAX. To be clear, does this effectively do the same thing as VMIN, just taking the other side of the trade?

Greg King: It does, yeah. That fund is down quite a bit. We see them as tools in investor portfolios. Those who want to take the position of being short accrue that potential benefit but take the risk that there's a big spike in volatility - those investors like VMIN. The ones who are betting on a spike in volatility and want to be the other way around, they prefer something like VMAX. I will say on VMAX, timing there is absolutely critical. That is much more of a trading vehicle.

Nate Geraci: Greg, in looking at your background, it's clear you have extensive experience with volatility-related products. I know you were at Barclays when the iPath S&P 500 VIX Short-Term Futures ETN was launched, ticker VXX. That's currently the most popular volatility exchange-traded product. You also co-founded VelocityShares. They offer the most popular inverse VIX product, the VelocityShares Daily Inverse VIX Short-Term ETN. Let's talk about investor education in this space because you do understand this space as well as anyone in terms of how these products are constructed. You just mentioned two words that caught my attention. You mentioned these ETFs as “tools” and you also used the word “betting”. Who should consider using VIX-related ETFs?

Greg King: Great question, and the answer is, of course, it depends. I've seen everything from intraday strategies to long-term strategies constructed with these types of products. I think that the way we think about it is investors who want to invest or trade these products should probably fit both of the following characteristics. Number one, they need to be willing to actively monitor their investments. I don't mean that necessarily they need to actively trade. We do see that. I think it's possible to invest profitably with these products while actively monitoring and trading as necessary according to a strategy. That's number one, you've got be actively monitoring your investments.

Number two, I think you have to have a hunger to learn. I've been in VIX products for a while, and I always feel like I'm still learning. I think investors, it only accrues to their benefit to recognize that maybe they've identified a strategy that's working, but doesn't mean they've figured it all out. Stay hungry, stay learning, and always keep moving forward. That's what we tell people. Yes, I agree, there's still a lot of education to be done in this space.

Nate Geraci: On your point on learning, I think many investors see the daily VIX spot price and they assume that's the return they're going to get on their exchange-traded product, or some inverse or leveraged factor of that return. What are some of the most important points you think anyone investing in VIX-related ETFs should understand?

Greg King: First of all, I think back to earlier in the conversation, the VIX is a number that's backed out of options prices and is not investible. What all the ETFs and ETNs generally do is invest via VIX futures. If you go to our website, volmaxx.com, that's V-O-L-M-A-X-X .com, we have a chart that we actually got permission from the CBOE to show. It really shows the relationship between futures prices and the VIX. Your one-month future tends to only have about a .5 beta to VIX prices. That's the punchline. A lot of these products are constructed using futures within about that timeframe, and so they're going to have quite a bit of deviation from what you see on CNBC with the VIX. If you start to understand that and accept it, start to understand how these products work, there's certainly a lot of potential to run profitable trading strategies using them.

Nate Geraci: We always talk about how ETFs have democratized investing. In the case of VIX-related ETFs, they certainly fit the bill, right? They allow investors to forego the hassle of opening a futures account and buying or selling futures contracts and options. Just at a high level and, on the balance, do you think that's a good thing for everyday investors?

Greg King: Look, I think philosophically, absolutely people should be encouraged and allowed to gain access to portfolio investment and management tools. I think the way you've seen the ecosystem develop is that intermediaries - because no one can go out and trade these with us or any of the other product providers - you have to go through your brokerage account - and brokerage accounts have taken different views. They, often case for VIX products, require investors to sign essentially a statement saying that they understand what's going on with these types of products or that they fit an aggressive risk profile, etc. Other more conservative brokerage houses have really not allowed VIX products on their trading platforms. We think that that's their call. They know their clients' risk tolerance, etc. We do believe in democratizing access to the capital markets generally. Yeah, I think it's a good thing.

Nate Geraci: We're visiting with Greg King, Founder and CEO of REX Shares. Greg, lastly before we let you go, let's talk a little bit about the current market environment. Given the news headlines - Trump, the Fed, North Korea, so on and so forth - I think many investors would have expected a lot more volatility this year. I'm just curious, why do you think volatility has been virtually non-existent?

Greg King: Yeah, great question. We always wind up circling back to that in discussions. It really is interesting. We were just talking about it internally again yesterday. To me, the answer starts with interest rates and what happened with '08. I think we're still in that environment. Even though the interest rates have gone up, I think you've seen the structural shift in terms of the acceptance of volatility selling strategies for yield enhancement and for just return enhancement generally. I think that the number of investors and the number of professional traders that are focused on volatility selling for return purposes has just structurally shifted and increased, and that was driven by interest rates.

As to why, in July of 2017, we're hitting potentially all-time lows in the VIX, I don't have an answer for that other than summer doldrums, etc. There does seem to be a pretty big structural shift that's taken place. I'm not sure when that changes. I'm not saying it never could, but I would expect that interest rates would have to move materially higher for that to change a whole lot, or a big, big market move to the downside.

Nate Geraci: We have about a minute left here. Do you think volatility is predictive at all? In other words, should investors be concerned about a lack of volatility? Does that suggest storm clouds on the horizon or can we glean anything meaningful from a lack of volatility in terms of what may happen moving forward?

Greg King: I don't think it's a very good predictive tool. I think that it is implied volatility, which is what we're talking about with VIX. It really just gets priced as a function of realized volatility. The real question we need to be asking is, why has realized volatility been so low, because if implied is 9, then dealers are pricing that because realized has been 6 or something like that. There you start to get into questions like why has the S&P gone up so consistently for the last eight years? You start to get into questions about corporate buybacks and all the cash that's available there to buy on any dips, etc. To me, that circles back to interest rates and corporate balance sheets. I don't know that the VIX is predictive. I think that investors should look at it as part of their keeping a temperature on markets, but I wouldn't say that it's got strong predictive power.

Nate Geraci: Greg, with that, we'll have to leave it there. Excellent spotlight today, great perspective on the current low vol market. As always, we certainly appreciate your time.

Greg King: Great, thanks again, Nate.

Nate Geraci: That was Greg King, Founder and CEO of REX Shares. Again, the ETF is the REX VolMAXX Short VIX Weekly Futures Strategy ETF, ticker symbol VMIN. You can learn more about this ETF, along with VMAX, by visiting rexetf.com.