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I came across an interesting pair of VIX ETPs, VXUP and VXDN. This new product referred to as "paired class shares" ETFs are quite different from traditional ETPs. Some interesting highlights from the prospectus.

"The Fund will hold only cash, short-dated U.S. Treasuries or collateralized U.S. Treasury repurchases. The Fund will not invest in equity securities, futures, swaps, or other assets that may track its Underlying Index."

"Unlike other exchange traded products, the fund will engage principally in cash distributions and potentially paired share distributions to deliver to the shareholders the economic exposure to the fund’s underlying Index, the CBOE Volatility Index."

"The Fund Will Only Effect Creations and Redemptions in Creation Units Composed of Equal Quantities of Up Shares and Down Shares."

It seems to me it solves some of the problems with other vix ETF/ETNs (credit risk and futures roll contango). However it also seems many more problems are caused, the potential for frequent distributions to eliminate premium/discount can be a tax burden for instance. These distributions will also ensure the up and down shares maintain a certain ratio of aum such that a large movement or redemption in one share class will topple the entire fund.

My question is what are the underlying mechanics that make this work?

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VXUP and VXDN are very new. They have only been in existence for 8 days.

Date VXUP VXDN VIX

5/29/2015 28.47 21.59 13.84

5/28/2015 28.39 21.69 13.31

5/27/2015 28.10 21.65 13.27

5/26/2015 28.91 21.1 14.06

5/22/2015 28.00 21.89 12.13

5/21/2015 28.29 21.86 12.11

5/20/2015 28.51 21.59 12.88

5/19/2015 27.64 22.35 12.85

So far they appear to be doing a poor job of tracking the VIX. For example on May 26 VIX increased by 16% but VXUP only increased by 3.25%.

So in addition to being bafflingly complex (as shown by the prospectus) the structure does not seem to work properly, at least so far.

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I found a blog post that does a great job summarizing the mechanics behind them.

Another great article on the relationship between the pair and the future.. Which may have an impact on linearizing the VIX Futures Term Structure?.

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