Time To Add Some Volatility To Your Portfolio

| About: iPath S&P (VXX)


1. The VXX has bucked its historical trend (negative 1:1) with SPY this quarter, potentially corresponding to worry that the market needs to correct.

2. During periods where the S&P 500 has sold off, the gain in VXX has outpaced that decline.


Wednesday was quite a day for volatility traders. The VXX - iPath S&P 500 VIX Short Term Futures ETN - jumped 5.9 percent to close at $21.20. This jump happened on just a 0.8 percent decline in the SPDR S&P 500 ETF (NYSEARCA:SPY).

Since VXX was created in 2009, there has been a 95.3 percent run-up in the SPY, and a corresponding 95 percent decline in VXX. Pretty much negative 1:1.

For the quarter, however, the VXX is higher by 4.2 percent, even though the SPY gained 3.9 percent.

However, during times that the SPY declined, the VXX outperformed that decline - substantially. Take the April 27-June 1, 2012 decline in SPY, which stretched to 8.7 percent. The VXX gained 40 percent over that time period. During the 3.2 percent decline in the SPY in November 2010, the VXX gained 6.8 percent. (In November 2010 and October 2012, the VXX did two reverse 4:1 splits - these percentages are in adjusted terms.)

The Bear Case for the Market:

The chart below - put together by DoubleLine Funds and encompassing time through the early part of 2013 - shows how the Fed's balance sheet has grown in comparison with the run-up in the S&P 500 - a 0.87 percent correlation.

S&P 500 vs Fed Balance Sheet

But, looking closer, the S&P 500 has led the Fed's actual balance sheet expansion (denoted by the bold line above), except the time period in mid-2011 to early-2012 timeframe.

However, recently the Fed's balance sheet has been steady - now at $3.4 trillion. Over the past six months, the Fed's Balance sheet has grown some 9 percent, from its previous $3.1 trillion. This has corresponded to a 6.5 percent increase in the SPY and 11.6 percent decline in VXX.

But, the balance sheet may be approaching its max. The balance sheet now sits at four times its usual size. With just six months left in his term, the Fed's balance sheet also becomes a political liability and, as much as no one wants to admit it, the Fed is a political body. Chairman Bernanke - who is unlikely to be renominated - may want to set the trajectory for his legacy, the Fed's exit, rather than leave the entire process out of his control.

So, why the VXX over the TVIX?

Put simply, TVIX (double VIX Short Term ETN) may ultimately gain more in the move back to volatility, but it is not an investable product. The problems with TVIX have been well documented, but to quickly rehash:

· Year-to-date, TVIX has declined 64.2 percent, while VXX has fallen 33.3 percent. This is compared to a 13.6 increase in the SPY.

· TVIX does not have options associated with the ETN, while the VXX does. Having the option to either protect yourself on the downside if you choose to hold the ETN for a longer period of time or to collect premium by selling calls against your long is never a bad thing.

· The problems with ETNs - mainly that contango (price of longer-dated contracts are more expensive than the current month) eats away at the ETNs assets.

· TVIX is particularly suspect following a 50 percent decline in March 2012. The sell off was prompted by a decision on the management's side to issue new shares. Prior to that decision, TVIX was trading at a premium to net asset value, which was unsustainable.


I believe that this quarter's counter-trend is the start of a new indicator that will, when combined with the Fed's inevitable tapering, lead the VXX to not only outperform a decline in SPY, but to do so exponentially.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.