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Market Extra: A bet on stock-market volatility might saddle investors with hundreds of millions in losses, as Barclays makes a big change to funds

Market participants attempting to bet on the stock market’s volatility are facing a reckoning Tuesday, with the possibility of hundreds of millions in losses in sight as fund provider Barclays says it has suspended the sales and issuance of new shares of a VIX-pegged instrument.

Barclays said it temporarily stopped the creation of new shares of the iPath Series B S&P 500 VIX Short-Term Futures ETN
VXX,
+7.71%
,
as the exchange-traded note has seen its value surge in recent days amid concerns about the war in Eastern Europe and worries about inflation and the potential for monetary policy missteps.

“They just halt creations when they get nervous,” Eric Balchunas, senior analyst at Bloomberg Intelligence, who focuses on exchange-traded products, including exchange-traded notes, or ETNs, and exchange-traded funds, told MarketWatch in a Tuesday afternoon interview, referring to Barclays.

The iPath Series B S&P 500 VIX Short-Term Futures ETN is designed to allow investors to bet on the size of swings in the S&P 500
SPX,
+2.13%
,
tracking an index linked to the daily readings of Wall Street’s so-called fear gauge, the Cboe Volatility Index
VIX,
-4.85%
,
or VIX.

ETNs and related ETFs are intended to trade close to the value of an underlying asset. While ETFs hold securities, ETNs hold unsecured debt obligations of an issuer, in this case Barclays, who promises to pay a return linked to a specified asset.

However, the cost of hedging the VIX product has soared for Barclays as the underlying asset has risen. The issuer has said that it doesn’t have the capacity to create more shares of the ETN and will resume creations once it does.

ETN debt essentially creates a liability on a banks’ balance sheet, which they must then hedge to comply with regulatory rules.

Halting new shares for the moment means shares of VXX, referring to its ticker symbol, will move out of sync with the underlying asset. It also means that investors who shorted VXX, selling borrowed share in a bet its price would fall, face difficulty finding shares they can buy to close their bearish positions.

“Investors can’t cover their shorts,” the Bl analyst said.

ETF.com describes VXX as a liquid volatility ETP, and says it is one of a handful that offers short-term VIX futures exposure.

Balchunas estimates that nearly half of the shares of VXX were held short — some estimates point to 90% — and that the run-up in shares is partly a function of short betters being forced to buy back VXX on the open market to unwind their short bets as the price surges. He speculated that today’s surge alone for VXX could result in some $200 million in losses for those making short bets.

“I feel like it’s a little bit of a selfish move,” Balchunas said of Barclays decision to halt creations. “ You can’t just offer a fund during the good times when it is easy and then halt creations in bad times,” he said.

“This suspension is being imposed because Barclays does not currently have sufficient issuance capacity to support further sales from inventory and any further issuances of the ETNs,” said Barclays in a statement.

“These actions are not the result of the crisis in Ukraine or any issue with the market dynamics in the underlying index components. Barclays expects to reopen sales and issuances of the ETNs as soon as it can accommodate additional capacity for future issuances,” the bank said.

This is the second iteration of the iPath VIX product. It was originally launched in 2009, but on Jan. 30, VXX was delisted in an unusual event for such a popular product. Barclays launched a virtually identical product that traded soon thereafter, with call features like a bond, highlighting the debtlike nature of the product.

Barclays also halted creations of the iPath Pure Beta Crude Oil ETN
OIL,
-5.48%
,
which is down 8.4% for the week thus far, but up over 28% in the year to date, moving along with prices of crude-oil futures
CL.1,
-6.82%
.

Oil prices and stocks have been particularly volatile as investors monitor developments between Ukraine and Russia, with that conflict helping to inject a fresh dose of volatility into already-unsettled markets.

The measure of implied volatility for stocks, the VIX, which tends to move inversely with stocks, is up 78% so far in 2022, compared with steep year-to-date losses in the S&P 500, Dow Jones Industrial Average
DJIA,
+1.92%

and the Nasdaq Composite Index
COMP,
+2.76%
.

The moves in ETNs come after short volatility products, notably the VelocityShares Daily Inverse VIX Short Term ETNand the ProShares Short VIX Short-Term Futures ETF, imploded back in 2018.

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