The fourth quarter GDP number witnessed a minute shrink of
-0.1%, however, little did it contribute in underwhelming the mood
of the stock market. Investors probably realize that the shrinkage
was just another aftermath of Superstorm Sandy rather than
weakening economic fundamentals of the nation.
Further recent trade deficit data and the decline in wholesale
inventories suggest that the GDP data will likely be revised
With corporate earnings season proving to be better than
expected and other economic data showing signs of a positive
momentum, the equity markets seem to be poised for further upmove
from current levels, even though the markets did take a slight dip
yesterday after the release of the FOMC minutes. (read 3 Ways to Play the S&P 500 Rally with ETFs
There are a number of products in the exchange traded products
(ETPs) space that enable investors to gain exposure in the broader
equity markets in order to take advantage of this situation.
However, choosing from these options require a thorough
understanding of their investment strategies and risks involved.
These products should be analyzed keeping in mind one's own risk
return tradeoff before any investment decisions.
In the light of the above, we would like to highlight two such
products that provide an exposure to the S&P 500. However,
their strategies differ substantially from other products offering
similar exposure. Also, these products are derived from volatility,
naturally these products demand a steady appetite for risk (read 3 ETFs at the Heart of The Recent Rally ).
Short volatility ETFs in a way
provide a long (i.e. positive) exposure to the S&P 500
Index. Since the Volatility Index (VIX) measures the expected
(implied) volatility that the S&P 500 is going to witness in
the next 30 days, the movements of the VIX and the S&P 500 are
inverse in nature. And naturally, any product that bets against the
VIX will surely provide a long exposure to the S&P 500.
The Short VIX Short Term Futures ETF ( SVXY ) and the VelocityShares
Daily Inverse VIX Short Term ETN ( XIV ) are two such ETFs. In fact these
two ETFs have a very high correlation of more than 80% with the
S&P 500. Naturally, such high correlation suggests that these
two ETFs certainly do bear a direct relationship with the S&P
These two ETFs are very similar in terms of their investment
objectives and strategies. They provide inverse daily exposure to
the spot VIX level by taking exposure in the volatility futures
contracts. The ETFs seek to provide a daily rolling short position
in the immediate first and second month of VIX futures contracts.
The contracts are rolled over on a daily basis (see Volatility ETFs: Three Factors Investors Must
While the strategy looks complicated, the underlying explanation
is very clear. These ETFs thrive when the market sentiment is
upbeat and the fear level is low. This situation reduces the
implied volatility in the market which in turn helps these ETFs to
post significantly high returns.
Furthermore, the ETFs' short term focus helps it them magnify
gains further since the short term future contracts are more
sensitive to contango. Yet for a change, contango which is
considered to be the biggest worry for futures backed products is
actually helping them.
This is especially true considering two very important factors
1) the inverse nature of these products, coupled with 2) A heavy
contango across volatility futures curve due to the broader market
surge of late. These two factors along with the short term focus
have resulted in a terrific run for these two ETFs.
The chart above represents one year comparative performance of
three products (including SVXY and XIV) which can be utilized by
investors to bet on the S&P 500 uptrend. The other product is
the SPDR S&P 500 ETF ( SPY ) which tracks the S&P 500
Not surprisingly, the inverse VIX ETFs have outperformed SPY by
an unbeatable margin. This disparity in returns has been due to the
daily rebalancing technique of the inverse VIX ETFs coupled with
the contango effect. Over the last one year XIV and SVXY have
returned 150% and 146.30% respectively, compared to SPY returning
14.02% (see Three Surging ETFs with Strong Momentum ).
However, these inverse volatility ETFs are not meant for
everyone. These products are vulnerable even to the slightest
movements in the underlying market. The annualized standard
deviations for these two products are around 69% each which shows
that these products are extremely volatile in nature. Nevertheless,
for well informed investors having an above par risk tolerance,
these two ETFs can surely be a fantastic bet.
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. Click to get this free report >>SPDR-SP 500 TR (SPY): ETF Research ReportsPRO-SH VIX STF (SVXY): ETF Research ReportsVEL-INV VIX ST (XIV): ETF Research ReportsTo read this article on Zacks.com click here.Zacks Investment
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