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ProShares Introduces CDS ETFs


Two new credit products came on the market today, and they're not for everyone.

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Proshares launched a series of new Credit-Default Swap ETFs today.

The first two (of four in total) are the short and long version of the US High-Yield CDX indices (the short version buys the index), trading under the following names and tickers:

ProShares CDS North American HY (TYTE)
ProShares CDS Short North American HY (WYDE)

The liquidity in the underlying instruments is very high, trading more than $8 billion per day, which is very high for a single credit instrument.

Here's the main problem with these ETFs, and it's the same problem that the various VIX ETFs run into because they must invest in futures. A new CDX index is launched every six months with a duration of five years.

However, similar to how the VIX curve trades in contango, the near-term expirations are lower in price than the more distant ones. The CDX curve is steep 99% of the time, except in times of a credit crisis when spreads are wider for very short-term notes because the risk of default is perceived to be higher in the short term as it is in the long term. The index will roll down over time as its duration shortens, similar to how a bond rolls down over time as it gets closer to maturity.

Unlike a traditional bond ETF or mutual fund, these ETFs will be unable to keep a constant duration due to the lack of a product in the market to allow them to do so. One possibility is that they could keep a constant duration of 4 by doing a ladder of sorts using old indexes. The risk there is that liquidity is far worse. I could not find any information in the prospectus to indicate if they would use this strategy. Without it, the short index that buys protection will fall over time due to the rolldown going against it, and the long index that sells protection will rise over time.

For an example of how this type of mechanic plays out, see the charts of the VIX ETFs VXX (long version) and SVXY (short version):

On a point basis, this would be a full point over a six month period for the CDX, but I am not sure how the ETF will treat that (for example one point of steepness is worth 8-10% over a 30-day period for VIX at around 13).

I would highly suggest that if you wanted to protect yourself against credit losses, or keep a credit hedge, use the ETF's JNK and HYG. They have started to act like the CDX indexes themselves, which are by nature hedging instruments.They also are far more liquid with a extensive trading history.

Fair disclosure: Even though I've read through the offering statements, there's a decent chance that I'm misunderstanding how these products will be run. My goal is to not be hyperbolic. .

Twitter: @MichaelSedacca

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