Recent equity market swings have been exhilarating for the high-frequency traders who rushed home from August vacations to cash in. For the rest of us, the feeling is a bit closer to having just stepped off the amusement park ride wondering if your corn dog lunch might suddenly reappear.
But wait, isnât there a slew of ETFs that track volatility so main street investors can cash in too? Yes. The largest of these is the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca:VXX). It boasts over $1.148 billion in assets as of Aug. 17.
Did investors in VXX fare well over the most volatile days? Depending on where you measure it, probably yes. Letâs grant you perfect clairvoyance and say you bought VXX on Friday afternoon, Aug. 5, just before the news broke about the S&P downgrade of U.S. Treasurys. Letâs further assume that your exit strategy was to sell VXX as soon as the broad-market broke even. That means you would have got out on Monday, Aug. 13.
Bully for you. Your return would have been 6.17 percent for the six-day period, according to Bloomberg.
This graph shows that products like VXX can work in the short term, assuming you have the skill or luck to get the timing right.
But the short term is the only way to use these funds in my view. There are two main reasons for this.
First, VXX does a lousy job delivering the returns of the VIX itself, the CBOE Volatility Index. Simply put, the VIX index is not investable. VXX and similar products do the best they can to match the VIX index using derivativesâspecifically, futures on the VIX. But the year-to-date results arenât pretty.
Thatâs right:The VIX index is up 85 percent for the year, but VXX is down 12.6 percent. In fact, VXXâs dive since inception forced a reverse 1-for-4 split in November 2010.
The mismatch stems mostly from contango in the VIX futures curve. VXXâs underlying indexâwhich is not the VIX indexâbuys front-month futures. (I say âbuysâ to describe exposure. Indexes donât buy and sell. And because VXX is an ETN and not an ETF, it doesnât buy or sell anything either.) Because the VIX futures curve has had an upward slope for most of the past years, the index essentially buys high and sells low. Not good.
Other volatility funds try to avoid this trap by getting exposure farther out on the VIX futures curve. The iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca:VXZ) buys contracts seven months out, selling them at four months.
A year-to-date graph of VXX and VXZ highlights the second problem with holding these funds long term:volatility. VXZ shows lower volatility and better returns than VXX. But their rides can only be called wild and wilder.
So while these products donât provide good long-term returns based on volatility, they do deliver volatility in their returns. Again, not good.
Thereâs fast money in these funds. For example, on Monday, Aug. 15, the âexitâ day for my vignette at the top, $205 million net flowed into VXX, according to IndexUniverse data. For many of these investors, Iâm guessing âlong termâ probably means morning âtil lunchtime.
The bottom line:Funds like VXX and VXZ can deliver positive short-term results in times of great uncertainty if you can get the timing right. But donât hold them any longer than you have to.
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