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Make Volatility Work for You – With Volatility ETFs

vol.jpg

BY: HANS ALBRECHT, CIM®, FCSI, VICE-PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS

What is a Volatility ETF?

A volatility ETF seeks to replicate the performance of an index that tracks the level of options volatility on major stock indices. For example, Horizons ETFs offers a suite of BetaPro volatility ETFs whose performance is referenced to the daily performance of the S&P 500 VIX Short Term Futures Index. They include the BetaPro S&P 500 VIX Short-Term Futures™ 2x Daily Bull ETF (HVU), the BetaPro S&P 500 VIX Short-Term Futures™ ETF (HUV) and the BetaPro S&P 500 VIX Short-Term Futures™ Daily Inverse ETF (HVI).

Why Own a Volatility ETF?

Typically, an investor would own volatility ETFs like HVU or HUV because they anticipate that the stock market volatility will increase. Conversely, they would want to own an inverse volatility ETF, like HVI, if they anticipated that volatility would decline. Historically, spikes in volatility coincide with negative returns in the stock market, so volatility has been one of the few areas where an investor would have made money during periods of stock market impairment.

The widely followed CBOE Volatility Index® (commonly known as the “VIX”) is the measure most U.S. stock investors use to gauge stock market volatility; however, it is not an investable index. The best-correlated benchmark, in our view, to the actual VIX is the S&P 500 VIX Short-Term Futures Index, which is also an uninvestable index. The volatility ETFs offered through Horizons’ suite of BetaPro ETFs have investment objectives that reference the daily performance of S&P 500 VIX Short-Term Futures Index. It is important to recognize that volatility ETFs do not replicate the VIX, but rather an index that has a high correlation to the performance to the VIX.

The example below shows that even in extreme market events, the performance of each of the volatility ETFs offered through BetaPro correlates to the performance of the S&P Short-Term VIX Futures Index, in the intended manner, with a high level of precision. Due to both the rolling nature of the futures contracts that underlay this index, as well as the fact that the ETFs’ exposure to this index is reset on a daily basis, the ETFs would only be expected to deliver precise replication for the stated daily investment objective. Returns for the leveraged and inverse ETFs, for periods of greater than one day, could and do vary from the index.

Case Study: Brexit

Thursday June 23, 2016

A referendum is held to decide whether the United Kingdom should leave or remain in the European Union. Leading up to the event, the markets believed that there was little chance that the U.K. would opt to leave. In fact, markets were so confident that the S&P 500 actually ended the day with a gain.

• S&P 500 Index (+1.34%)
• S&P 500 VIX Short term Futures Index (-13.21%)
• Horizons S&P 500 VIX Short-Term Futures 2x Daily Bull ETF (-26.31%)

Friday June 24, 2016

The referendum results came in at 1:20 a.m. (EST) triggering one of the most dramatic and volatile trading sessions in the past decade.

• S&P 500 Index (-2.30%)
• S&P 500 VIX Short term Futures Index (+32.71%)
• Horizons S&P 500 VIX Short-Term Futures 2x Daily Bull ETF (+66.45)

Brexit Chart

Source: Bloomberg, between June 22, 2016 and June 29, 2016.
The rate of returns shown in the chart are used only to illustrate the effects of compound growth rate and is not intended to forecast, imply, or guarantee the future performance of any particular investment of the indices shown, which will vary. The performance data for all of the indices shown assume no commissions, management fees, expenses, taxes or other charges that would have reduced returns, and includes the reinvestment of all distributions.

Name Ticker 1
Month
3
Month
6
Month
YTD 1
Year
3
Year
5
Year
Since
Inception
S&P 500 VIX
Short-Term Futures
2x Daily Bull ETF
HVU -42.65% -70.29% -80.16% -42.65% -97.32% -86.63% -89.40% -86.98%
S&P 500 VIX
Short-Term
Futures Index
SPVXSP -23.74% -43.33% -51.97% -23.74% -79.58% -53.67% -58.88% -54.48%
CBOE VIX Index® VIX -14.60% -29.72% 1.01% -14.60% -40.64% -13.31% -9.20% -6.36%

Source: Bloomberg, between December 15, 2010 and January 31, 2017.
Performance greater than one year is annualized.
The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. Only the returns for periods of one year or greater are annualized returns.

Investment Objectives:

BetaPro S&P 500 VIX Short-Term Futures™ 2x Daily Bull ETF (HVU): Seeks investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs that endeavour to correspond to the performance of the S&P 500 VIX Short-Term Futures Index™. Any U.S. dollar gains or losses as a result of the ETF’s investment will be hedged back to the Canadian dollar to the best of the ETF’s ability.

BetaPro S&P 500 VIX Short-Term Futures™ ETF (HUV): Seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs that endeavour to correspond to two times (200%) the daily performance of the S&P 500 VIX Short-Term Futures Index™. Any U.S. dollar gains or losses as a result of the ETF’s investment will be hedged back to the Canadian dollar to the best of the ETF’s ability.

BetaPro S&P 500 VIX Short-Term Futures™ Daily Inverse ETF (HVI): Seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs that endeavour to correspond to the inverse (opposite) of the daily performance of the S&P 500 VIX Short-Term Futures Index™. Any U.S. dollar gains or losses as a result of the ETF’s investment will be hedged back to the Canadian dollar to the best of the ETF’s ability.

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