Low Volatility: A Potentially Fleeting Gift From The Central Banks

Includes: TVIX, VXX, VXZ, XIV
by: Larry Trefz

It is generally accepted that the Federal Reserve is currently the single largest market force. Since the financial crisis that force continues to operate more aggressively than ever. The primary object of this unprecedented central bank action has been to bring a feeling of confidence back into the markets.

The power of a stable digitalized currency controlled by the central banks has allowed the developed world to experience a boom cycle that started after WWII (partly as a response to the great depression) and ended with the housing crisis bubble bursting in 2007 which led to the credit freeze of 2008-09. This half-century boom cycle coordinated with the demographic tailwind of the baby boomer generation.

The relative absence of any serious bust cycle in that 50 year boom time-frame led to the creation of a super-bubble. The super-bubble is now in danger of deflation, at the same time that the baby boomer generation is retiring at 10,000 per day. This potential bursting (a crash over a relatively short period of time) of the super-bubble, which started in 2008-2009, has the potential to lead to the biggest deflationary threat ever faced.

This deflationary threat is what the central banks are currently attempting to fight by adding huge amounts of liquidity to the financial system. This causes imbalances and bubbles of its own. The biggest problem right now is that wages are continuing to experience deflation while commodities and assets are being propped up by the Fed's monetary easing actions. This causes poorer people to struggle even more and seek government assistance, which further burdens the government's finances with debt and requires higher taxation, which in turn leads to a slower economy--a potentially vicious cycle.

The success that the central banks have achieved in the last four years by infusing the markets with the feeling of confidence has resulted in reducing market volatility to a nearly all-time lows, as measured by the Volatility Index (VIX).

The trillions of dollars put to work by the central banks have driven volatility out of the markets and forced the ETFs and ETNs that track the VIX to previously unimagined lows.

As US equity indexes are fast approaching all-time highs, the ETF and ETN products that track the VIX may become some of the best deals available as they have been the most pointedly targeted part of the market by the most powerful force currently at work - the central banks.

There are at least twenty ETF and ETN products that are available for investors wanting to play market volatility.

VXX - iPath S&P 500 VIX Short-Term Futures Exchange Traded Note. This is one of the more more popular volatility products. It is a long, unlevered, ETN which is designed to track VIX futures. It has recently been trading about 36 million shares a day. It is currently trading at about a quarter its value 12 months ago.

XIV - VelocityShares Daily Inverse VIX Short Term Exchange Traded Note. This product attempts to provide a short position in VIX futures. It is up over 100% in the last 12 months.

TVIX - VelocityShares Daily 2x VIX Short Term Exchange Traded Note. This ETN is a long, double levered product. It is designed as very short-term trading instrument and is generally considered very risky as it has plunged very sharply at several points in recent months, far out-pacing the drop in the VIX.

VXZ - iPath S&P 500 VIX Mid-Term Futures Exchange Traded Note. This product is designed to provide a long, unlevered position in mid-term VIX futures. It attempts to track VIX futures that are dated further into the future than the other products mentioned above. It has recently been trading about half a million shares per day.

Disclosure: I am long VXX, TVIX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long several volatility ETFs and ETNs