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NEWSLETTERS & ALERTS
Rules & Regulations
Sales Practice Obligations for Volatility-Linked ETPs - FINRA
Volatility ETPs are designed to track CBOE Volatility Index (VIX) futures, rather than the VIX itself. As explained below, many volatility-linked ETPs are highly likely to lose value over time. Accordingly, volatility-linked ETPs may be unsuitable for certain retail investors, particularly those who plan to use them as traditional buy-and-hold investments.
The VIX is frequently cited as a measure of investor fear, which historically tends to be elevated in periods of market distress and lower under normal market conditions. The VIX often moves sharply higher when stock indices decline significantly. As such, the VIX has the desirable attribute that it is negatively correlated with the broader stock market.
Volatility-linked ETPs generally provide exposure to volatility by tracking short- and mid-term VIX futures indices. Volatility-linked ETPs that seek to maintain a continuous, targeted maturity exposure to VIX futures will either track or hold VIX futures contracts on a rolling basis, meaning that they will sell shorter-term contracts or contracts about to expire with contracts that have more distant or deferred maturity dates in order to maintain the desired exposure.
PRICE PERFORMANCE OF 'VIX FUTURES' AND 'VOLATILITY ETPS'. Historically, the prices for VIX futures have tended to increase as the futures contract dates go out farther into the future, so the strategy of maintaining a targeted maturity exposure to VIX futures can often involve selling a contract with a lower price than the one bought to replace it. This rolling of contracts can result in a loss on the trade or a negative roll yield.
Because of the negative roll yield, many volatility-linked ETPs that seek to maintain a continuous, targeted maturity exposure to VIX futures, particularly to shorter maturities, have lost a significant amount of value over time; some have lost more than 90% of their value since they launched. And, such products will likely continue to lose value over longer periods of time.
Moreover, the performance of VIX futures can diverge from that of the VIX, and in general, movements in the futures are smaller in magnitude than those of the VIX. For these reasons, the performance of volatility-linked ETPs that seek to maintain a continuous, targeted maturity exposure to VIX futures may also be less correlated to that of the VIX than investors might expect.
Without understanding the key features of these volatility-linked ETPs, some investors and registered reps could mistakenly believe that these products are likely to exhibit behavior similar to that of the VIX over short as well as long time horizons and thus provide protection against market losses over a variety of time periods. In fact, these products have not exhibited, and likely will not exhibit, behavior similar to the VIX over longer periods and exhibit imperfect correlation even over shorter periods.
REFER TO FINRA REGULATORY NOTICES 17-32 AND 12-03. In RegNote 17-32, FINRA reminds firms of their sales practice obligations in connection with Volatility ETPs as discussed more generally in RegNote 12-03, including, without limitation, that: (i) recommendations to customers must be based on a full understanding of the terms, features and risks of the product recommended; (ii) sales materials must be fair and accurate; and, (iii) firms must have reasonable supervisory procedures in place to ensure that these obligations are met.
DIRECT FURTHER QUESTIONS TO:
- Thomas Selman, EVP, Regulatory Policy: (202) 728-6977; Thomas.Selman@finra.org;
- James Wrona, VP and Assoc. GC, Office of General Counsel: (202) 728-8270; Jim.Wrona@finra.org; or
- Kathryn Moore, Assoc. GC, Office of General Counsel: (202) 728-8200; Kathryn.Moore@finra.org