Volatility-linked ETFs

VolatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition-linked exchange traded funds (ETFs) are high-risk, complex investments. These products are typically suited for financial professionals or investors who understand advanced investing strategies and are willing to take significant risk, including the possibility of losing their entire initial investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition.

Despite its name, volatility-linked ETFs are very different from most other ETFs. You could risk major losses if you buy and sell volatility-linked ETFs without fully understanding how they work. Unlike most ETFs, volatility-linked ETFs are typically meant for short-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition trading which could sometimes mean owning the investment for mere hours. Some funds strongly advise against holding the product for more than one day. Holding volatility-linked ETFs for the long-term will likely expose you to even greater risks and further increase the likelihood of losing your money.

How these products work

Volatility-linked ETFs are bets for or against volatility in the stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition. Some of these products do well when there are major swings in the market such as a stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition market crash while others do well when the market is stable and there are no major changes.

The Chicago Board OptionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition Exchange publishes the Volatility IndexIndex A benchmark or yardstick that lets you measure the performance of a stock market, part of a stock market or a single investment. Examples: S&P/TSX, S&P/TSX Canadian Bond Index.+ read full definition or VIX which measures expected stock market volatility by looking at current S&P 500 option prices. A higher VIX value means more volatility is expected. This is sometimes called the “fear index” but what it really represents is how much stock prices are expected to move (upwards or downwards) over the next 30 days.

Since the actual VIX cannot be bought (it’s simply an index), most volatility-linked ETFs are based on VIX future contracts, which is a bet on what the value will be on a future date.

4 things you should consider

1. High-Risk

Volatility-linked ETFs are high-risk, speculative investments. These products bet on stock market riskMarket risk The risk of investments declining in value because of economic developments or other events that affect the entire market. The main types of market risk are equity risk, interest rate risk and currency risk.+ read full definition and values can change quickly in a very short period. This means you could lose your entire investment in mere hours.

2. Correlation

Since the VIX is simply an index, it cannot be bought directly. Instead, most volatility-linked ETFs use VIX future contracts to try to approximate VIX performance. Despite this, volatility-linked ETFs may not match how the stock market actually performs since VIX future contracts are based on future expectations, not current performance.

3. Complexity

Volatility-linked ETFs are complex investments, and their investment strategies may not be as straightforward as other products. This means that it may be difficult to predict how the fund would react if there was a sudden shock in the market – how much the fund would increase or decrease could depend on many factors.

4. Different than most ETFs.

You can buy a volatility-linked ETFs in much the same way you buy other ETFs; however, volatility-linked ETFs do not own assets (like bonds or other stocks) in the same way other ETFs do. These products are typically intended for short-term trading and many are designed to be held for no more than one day.

 

The number of investment products available to investors has never been greater. Volatility-linked ETFs are high-risk, speculative investments. Consider your risk tolerance and investment strategy before making a decision. Read the fund’s prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition and ETF Facts carefully to better understand how the product works and its risks.

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