## Feb 23, 2011

I've written before about XXV and its price connection to VXX. The formula for historical relationship between two ETFs is

XXV \$20 * (1 - (VXX-108.03)/108.03 ) = \$40 - VXX * (20/108.03)

That relationship has changed slightly, probably because of accrued fees / transaction costs. As I pointed out, it VXX falls to zero that provides a maximum for theoretical value of the ETF of \$40. Having risen 70% since its inception (using base value of \$20) in 7 months XXV does not provide much of an upside to investors, and will probably spend the rest of its existence going slowly to \$40. Apparently in response to this iPath launched IVO - an identical fund, but with a more recent start date. Now that IVO has been trading for a few weeks, I provide a similar formula for IVO:

IVO ≈ \$20 * (1 - (VXX-32.99)/32.99 ) = \$40 - VXX * (20/32.99)

The maximum value is still \$40, but return upside is greater.

It is clear that arbitrage is possible among all three ETFs. For example the following relationship holds between IVO and XXV

IVO ≈ \$40 - (40-XXV)*108.03/32.99

1. I am trying to figure out how XXV can be implemented. To have it follow the formulated behavior, at inception, starting with \$40 in cash, I short \$20 worth of VXX. This replicates XXV as long as VXX goes down - unbelievably simple. But what if VXX goes over \$40 - My account value will be negative and I'd get margin calls. What is it that dampens exponential upward moves in VXX and SPVXSP to logarithmic downward moves in XXV?

2. Hi Kenny,
XXV and IVO prevent your account from going negative by invoking what they call their "automatic termination event". This happens if their notational value drops below \$10. Nothing dampens the exponential move if VXX moves against you, instead you are effectively stopped out.

-- Vance sixfigureinvesting.com

3. Hi, Vance,
Thanks a lot for the piece of key information. That brings up a scary scenario. In event of "automatic termination", the mathematical relationship with VXX no longer holds. This happens with IVO (\$10) when VXX reaches 50. Stopping out would mean buying VXX at high. The problem s that the loss becomes permanent if VXX then gaps down to 30: IVO will miss out and stay low.

4. Why is it "scary"? If you're monitoring the market, and your ETF is getting close to termination value, it should not come as a surprise. If you're arbing the two that is just one of the risks.

5. Scary because the loss is a way-way street. What is good about XXV/IVO is that as long as you don't hit "automatic termination", no matter how low it gets, when VXX gets back down to the previous level, you recover your loss fully. This is different from XIV, which is not guaranteed to go up even if VXX goes down, while XXV is, except in the "automatic termination event".