August 02, 2011 - 4:30pm EST by
2011 2012
Price: 25.30 EPS $0.00 $0.00
Shares Out. (in M): 2 P/E 0.0x 0.0x
Market Cap (in $M): 38 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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I am long IVO and describe a portion of my rationale below.

IVO is simple to understand if you understand the flaws in the volatility ETNs and ETFs. I will not re-state them here as they've been generally covered in the two VXX write-ups as well as recently in the XIV write-up, though for an inverted reason. I can go on and on about this topic forever, and am tempted to, but will cut myself short here and expound in Q+A if so requested. I presume a reader understands this issue in the balance of my write-up.

[Quick note: despite IVO's apparently small market cap, it is an NAV based product and is, in fact, quite liquid due to its redemption/issuance process. iPath will happily issue more if demand is there.]

IVO is, quite simply, close to the effective equivalent of a VXX short - dollar for dollar benchmarked to IVO's initial issuance, but safer, in my humble opinion. 

IVO was issued at $20. That means its maximum price is $40 because, as any hedge fund LP will remind you, "in a short you can't make more than 100%." They'll also subsequently let you know "but you can lose more than 100%." Well, in IVO's case, because it is a long with losses bounded at 100%, it is actually much more balanced (actually, because iPath will call-in IVO notes before hitting zero, your max loss is likely less than 100%, though not for meritorious reasons).

If you have spent serious time in levered ETF/N world (collectively ETPs), you probably know that certain breeds of ETPs are not based on daily returns, but are based on the total return from issuance to some point in the future, causing the daily leverage factor to fluctuate a great deal over time. In IVO's case, as VXX moves, IVO's exposure to VXX's daily return changes from 1.0x VXX's daily return (no leverage) to something greater or less than 1.0x (as VXX declines, exposure to VXX's daily percentage returns decline and vice versa as VXX rises). The key is to think about the returns of a VXX short initiated at IVO's issuance - if VXX falls by half, a subsequent 5% decline is only a 2.5% movement on your initial cost basis. If VXX doubles, a subsequent 5% move is a 10% move on your initial cost basis. The math isn't quite this simple, because the price of your long IVO is going up or down as well, so in reality it becomes even more levered as it loses money and even less exposed as it gains.

IVO is the second in what I suspect will be a ongoing series of issuance by iPath. The predecessor is XXV (get it - VXX backwards). XXV, also issued at $20, is now at ~$35. In my mind, XXV has basically become a cash substitute as it will painstaking inch toward $40 due to the fact it has now de-levered over 90% (for example, when the VXX rises 5%, XXV declines by about 60bps). It took XXV all of about a year to rise from $20 to $35 as VXX continues its value destructive cratering. I believe IVO is on a highly similar trajectory - it will accrete closer and closer to $40, but on a slower and slower pace as it de-levers. I believe the 40% increase from $25 to $35 will take place in less than a year, barring any magnificent spike in vol, providing a very credible and mathematical return profile. At that point, you will have a cash substitute and can probably cycle into son-of-IVO if you are interested in continuing to compound.

Given the recent spike in vol futures prices and the continued vol futures contango, I believe now is a reasonable entry point.

Warning: ETNs are sold by Wall Street, presumably for their benefit, not yours. By being long an ETN, you are effectively opposing Wall Street. This may be an epically dumb thing to do and certainly is if you do so on the basis of an Internet posting without doing your own diligence. At some point in the future I and/or my firm will probably buy and/or sell IVO without telling you. At that point, I will likely chortle at how valuable that information would have been to you - allowing you to avoid the subsequent tornado strike that hits your portfolio...if only you had known what I/we was/were doing.  Drugs kill. May God save your soul.


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