Markets

Keep VXX On A Short Leash

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, isn’t 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. Let’s 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. Let’s 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.

VXX vs. SPY (Aug. 8 - Aug. 15, 2001)

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.

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 derivatives—specifically, futures on the VIX. But the year-to-date results aren’t pretty.

VXX vs. VIX:YTD, 2011

That’s right:The VIX index is up 85 percent for the year, but
VXX is down 12.6 percent. In fact, VXX’s dive since inception
forced a reverse 1-for-4 split in November 2010.

That’s right:The VIX index is up 85 percent for the year, but VXX is down 12.6 percent. In fact, VXX’s dive since inception forced a reverse 1-for-4 split in November 2010.

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The mismatch stems mostly from contango in the VIX futures curve. VXX’s underlying index—which is not the VIX index—buys front-month futures. (I say “buys” to describe exposure. Indexes don’t buy and sell. And because VXX is an ETN and not an ETF, it doesn’t 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.

VXX vs. VXZ vs. SPY:YTD

So while these products don’t provide good long-term returns
based on volatility, they deliver volatility their returns. Again, not good.

So while these products don’t provide good long-term returns based on volatility, they do deliver volatility in their returns. Again, not good.

There’s fast money in these funds. For example, on Monday, Aug. 15, the “exit” day for my vignette at the top, $205 million net flowed into VXX, according to IndexUniverse data. For many of these investors, I’m guessing “long term” probably means morning ’til 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 don’t hold them any longer than you have to.

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Don't forget to check IndexUniverse.com's ETF Data section.

Copyright ® 2011 IndexUniverse LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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