New products compete with iPath ETNs.

[CORRECTION: A previous version of this article had a number of errors, beginning with the suggestion that ProShares had launched an inverse volatility ETF. The errors are corrected below. We apologize for the mistakes.]

The new volatility products represent a new tack for ProShares, which has built its business primarily on offering leveraged and inverse ETFs. These new volatility products are neither. Still, they fit well within the ProShares product line-up, which is focused primarily on providing tools for the trading community.

VIX products have historically made poor investments, as contango in VIX futures have proven to be a drag on returns. They can, however, be useful for short- or intermediate-term trades, as they are often negatively correlated with the market and provide significant upside in volatile conditions.

The new ETFs are the ProShares VIX Short-Term ETF (NYSEArca: VIXY) and ProShares VIX Mid-Term Futures ETF (NYSEArca: VIXM). They are designed to provide exposure to futures contracts linked to the CBOE Volatility Index, or VIX, the market’s leading measure of volatility.

The new products will go head-to-head with the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) and iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ), which have attracted $1.38 billion and $692 million in assets, respectively, since launching in January 2009.

The ProShares ETFs track the exact same indexes as the iPath products, but differ in two important ways. First, the ProShares products are cheaper, charging just 0.85 percent in annual fees compared with 0.89 percent for the iPath products. Second, and more importantly, the ProShares products are ETFs, while the popular iPath products are ETNs.

ETNs are unsecured debt obligations backed by their issuer—Barclays, in the case of VXX and VXY. While Barclays is widely considered to be among the healthiest of financial institutions, ETN investors risk losing their entire investment should they be caught holding an ETN when its issuing bank declares bankruptcy.

ETFs, by contrast, actually hold the assets they track: in the case of the ProShares products, direct positions in volatility futures. That eliminates credit risk. On the flip side, it increases the potential for tracking error; after all, ETNs guarantee the return of the index they track (minus expenses), while ETFs actually have to go out into the real world and buy and sell assets.

ETNs are currently treated by the Internal Revenue Service like zero-coupon bonds, which means a note holder isn’t taxed until the note is sold, is called or matures. They generate 1099 IRS tax forms.

The ProShares are taxed as partnerships. Gains (or losses) in the ETF are marked-to-market each year and taxed annually on that basis. The fund generates K1 reports, which some investors don’t like.

The new products provide choice for investors who want to play volatility. You eliminate credit risk and lower expenses, at the cost of potential tracking error and a different tax treatment.

New Avenue For ProShares

The new volatility products represent a new tack for ProShares, which has built its business primarily on offering leveraged and inverse ETFs. These new volatility products are neither. Still, they fit well within the ProShares product lineup, which is focused primarily on providing tools for the trading community.

VIX products have historically made poor investments, as contango in VIX futures has proven to be a drag on returns. They can, however, be useful for short- or intermediate-term trades, as they are often negatively correlated with the market and provide significant upside in volatile conditions.