J.P. Morgan Inverse VIX Futures ETN: a more intuitive approach to risk

Brandon Igyarto and David Rademeyer discuss J.P. Morgan’s new inverse Vix futures ETN, designed for a more stable risk profile

Volatility has long been both a challenge and an opportunity for the investment community. The Cboe Volatility Index^® (Vix), often referred to as the ‘fear gauge’, measures market expectations of future volatility based on S&P 500 options prices. J.P. Morgan believes its latest launch – the Inverse VIX^® Short-Term Futures ETN – is designed to provide access to a ‘short-volatility’ strategy and address the shortcomings of previous volatility-linked products. This Vix exchange-traded note (ETN) features 20-year maturity and a refined approach to risk management.

Brandon Igyarto, managing director, head of Americas structured investment distributor marketing, and David Rademeyer, managing director, head of Americas equities structuring, share their insights into its structure, potential target investors and market positioning.

Addressing predecessor shortcomings

The financial industry has a history of innovative yet sometimes problematic Vix-linked products. Previous iterations were designed in a way that created significant exposure to shock during calm markets, which ultimately led to their performance deterioration.

As Rademeyer explains: “One of the features of the existing Vix exchange-traded products [ETPs], which performed very poorly in 2018, is that they take much more vega risk in low-volatility environments and much less Vega risk in high-volatility environments.” This design made them highly susceptible to sudden market crashes, such as the February 2018 ‘Volmageddon’, when volatility surged unexpectedly, wiping out many short-volatility products.

To understand why these products collapsed, it’s important to look at how they were structured. These legacy ETNs – each a short-volatility product – were designed to provide short exposure to the daily performance of Vix futures. However, when volatility spiked dramatically, the exposure provided by these legacy products led to significant buying of Vix futures.

This led to a vicious cycle that, ultimately, rendered the products almost worthless given they provided short exposure to an asset that was being pressured higher. The lesson from the downfall of these legacy ETPs is that short-volatility strategies, if not properly designed, can become highly unstable and prone to collapse during sudden market dislocations. These events underscored the need for a more resilient product that could withstand extreme market conditions.

J.P. Morgan’s new ETN seeks to overcome these pitfalls by utilising an original approach that is designed to provide a more stable risk profile. According to Rademeyer: “If those products had been structured in a constant risk way, as opposed to a constant notional way, you would have expected a very different outcome.”

Structural innovations

J.P. Morgan’s new ETN is built on a unique structure that differentiates it from its predecessors. The ETN offers exposure to the daily returns of the S&P 500 Vix Short-Term Futures Points-Change Inverse Daily Index, developed by S&P Dow Jones Indices.

Instead of relying on percentage changes, the ETN operates on a point-to-percentage basis, allowing for a more intuitive understanding of risk exposure. Brandon Igyarto explains: “If the reference Vix futures contracts go from 10 to 11, that would be a 1% move in our ETN before fees and the return on cash. In contrast, with prior designs, that same move would have been a 10% change before any fees and any return on cash.”

This innovative approach is intended to provide a more stable risk profile, particularly in volatile market conditions.

Rademeyer emphasises the importance of this structural change: “We believe the way we refined the design of this new ETN may address some of the issues investors had with previous products to a certain degree.”

By decoupling the product’s performance from the often erratic behaviour of Vix futures, J.P. Morgan aims to create a more stable risk profile for investors seeking short exposure to volatility.

This structural redesign also incorporates a more straightforward risk management approach. Rademeyer points out that the ETN’s design allows for daily liquidity and redemption rights, which are essential features that enhance investor confidence.

Simple, accessible design

This product is not designed for hedging against volatility but rather for investors who want to capitalise on the short-volatility trade. As Igyarto clarifies: “When people hear Vix, they immediately think hedge. The reality is, this is not going to be that.”

Instead, this ETN offers a more efficient way for investors to sell volatility, leveraging a well-established strategy that has been used in various forms for decades.

Historically, traders seeking to implement short-volatility strategies have relied on put writing, call overwriting or complex derivatives structures. However, J.P. Morgan’s new ETN provides a more direct and systematic approach. “Selling implied volatility through the cycle has been a trading strategy for decades,” says Igyarto. “This ETN makes that trade much more accessible in a linear way, without the issues the investors had with previous products.”

Moreover, retail investors who have traditionally found it difficult to participate in volatility-selling strategies because of high capital requirements may now find an entry point through this ETN. The new ETN may be accessible to investors who may not be able to trade futures, as well as to investors who want the flexibility afforded by ETPs.

Alternative returns

The introduction of this ETN is not only relevant for retail investors, but also for institutional investors seeking efficient exposure to volatility strategies. Hedge funds and proprietary trading firms often employ volatility-selling strategies as part of their broader portfolio construction. By integrating this ETN, they can access short-volatility exposure and trade in and out of their exposure as with a stock or exchange-traded fund.

Additionally, institutional investors seeking alternative sources of uncorrelated returns might view this ETN as a useful component within a diversified investment strategy. Volatility strategies often perform differently from traditional equities and fixed income, offering an alternative risk premium that can enhance overall portfolio returns.

The launch of this ETN marks J.P. Morgan’s first major step into the alternative return space via ETNs. While the firm has long been involved in exchange-traded structured products, this new product marks an expansion into volatility-linked instruments. “This will represent our first real foray into additional sources of alternative return,” says Igyarto. “We have an expectation to broaden out the range of ideas we bring via ETNs over the next few years.”

Conclusion

J.P. Morgan believes its new ETN is a thoughtfully designed product that attempts to address the shortcomings of its predecessors while providing a scalable way to engage in short-volatility strategies. With a structure that is designed to maintain a stable risk profile across different market environments, it offers a compelling option for investors looking to capitalise on implied volatility trends. As Igyarto concludes: “We think this has value, and we think there is opportunity. The implementation is intuitive, and we believe it provides an elegant solution to the challenges of trading volatility.”

For investors seeking alternative sources of return, J.P. Morgan’s new ETN could serve as an essential addition to their portfolio – offering innovation in an ever-evolving financial landscape.

_{Investors should consult with their brokers or financial advisers when making an investment decision and actively manage and monitor their investments in the Inverse VIX^® Short-Term Futures ETN (which we refer to as “the ETN”). Investing in the ETN involves a number of risks, including:}

_{• The ETN differs from conventional debt securities and may not return any of the investor’s initial investment.
• The ETN may not be suitable for all investors and should only be purchased by investors with the sophistication and knowledge necessary to understand the risks and potential consequences of investing in the ETN, including the risks inherent in the Index, the underlying Vix^® futures contracts and short investments in volatility as an asset class generally. 
• The ETN is subject to daily deduction of an investor fee.
• The ETN is subject to the credit risks of J.P. Morgan.
• J.P. Morgan may, in its sole discretion, elect to redeem the ETN in whole or in part on any business day after March 21, 2025.
• Investing in the ETN is not equivalent to taking a long position directly in the Index or taking a short position directly in the underlying Vix^® futures contracts or the Cboe Volatility Index^®.
• The ETN does not provide direct short exposure to the Cboe Volatility Index^® or the daily “percentage-change” return from the underlying Vix^® futures contracts.
• The investors in the ETN do not have any ownership interests or rights with respect to the assets included in the Index, the underlying Vix^® future contracts, the Cboe Volatility Index^® or the S&P 500^® Index.
• The ETN may not have an active trading market and may not continue to be listed over their term.
• The intraday or closing intrinsic value of the ETN is not the same as the closing price or any other trading price of the ETN in the secondary market. The trading price of the ETN in any secondary market may differ significantly from the intraday or closing intrinsic value of the ETN.
• The liquidity of the market for the ETN may vary materially over time, including as a result of any decision of J.P. Morgan to issue, stop issuing or resume issuing additional ETNs.
• The issuer’s obligation to repurchase the ETN is on a weekly basis and is subject to restrictions on substantial minimum repurchase size unless waived or reduced.
• Investors will not know how much they will receive upon early repurchase at the time that investors elect the issuer repurchase their ETN. Early repurchase will be subject to a repurchase fee unless waived by J.P. Morgan.
• The performance of the Index and the value of the ETN may be affected, perhaps significantly, by an increase in market volatility, which may happen suddenly.
• Roll costs when the underlying Vix^® futures contracts are in backwardation or reduced roll yields when the underlying Vix^® futures contracts are in contango will adversely affect the level of the Index and the value of the ETN.
• The Index may be adversely affected by a “volatility drag” effect.
• The Index provides short exposure to the daily “points-change” return of the underlying Vix^® futures contracts.
• The ETN is not linked to the options used to calculate the Cboe Volatility Index^®, to the actual volatility of the S&P 500^® Index or to the equity securities included in the S&P 500^® Index.
• The Index has a limited operating history and may perform in unanticipated ways.
• Hypothetical backtested data relating to the Index does not represent actual historical data and are subject to inherent limitations.
• The Index is subject to significant risks associated with the underlying Vix^® futures contracts.
• Concentration risks associated with the Index may adversely affect the value of the ETN.
• Suspension or disruptions of market trading in the underlying Vix^® futures contracts may adversely affect the value of the ETN.
• The official settlement price and intraday trading prices of the underlying Vix^® futures contracts may not be readily available.
• An increase in the margin requirements for the underlying Vix^® futures contracts may adversely affect the level of the Index.
• The ETN is not regulated by the Commodity Futures Trading Commission.
• The Index may, in the future, include a futures contract that is not traded on regulated futures exchanges.
• Changes in the secured overnight financing rate (SOFR) may affect the level of the Index and the return of the ETN.
• SOFR will be affected by a number of factors and may be volatile.
• The SOFR Administrator may make changes that could adversely affect the level of SOFR or discontinue SOFR, and has no obligation to consider the investors’ interest in doing so.
• Potential conflicts of interest: J.P. Morgan and/or its affiliates act as the issuer and the calculation agent for the ETN, co-ordinated with the index sponsor in the development of the Index, and hedge our obligations under the ETN.}

_{The risks identified above are not exhaustive. Investors should also review carefully the related Risk factors section of the relevant pricing supplement.}

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