VIX ETN: Ineffective as Both Short-Term, Long-Term Play

During the last month, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) has been turning over an average of 1.3 million shares per day. I am certain that a fair portion of the purchases of VXX have come from investors who have sought to protect their portfolios from an increase in volatility and/or downturn in stocks.

Unfortunately, VXX has considerable shortcomings, both as a short-term and a long-term play.

Investors who are long VXX hope that when volatility increases dramatically they will benefit by holding the short-term VIX ETN. In fact, when the VIX spikes 10% or more in one day, VXX generally does not cover even half of that move in percentage terms. The table below shows the eight instances since the January launch of VXX in which the VIX rose 10% or more in one day. The results speak for themselves, but in the eight instances over the course of eight months, VXX has been capturing only one third to two thirds of the VIX spike. Ironically, when the VIX is flat or falls, VXX does a much better job of keeping pace. The VXX juice factor (VXX movement as a percentage of VIX movement) shows just how disappointing the performance of VXX relative to the VIX is when the VIX spikes. The bottom line is that when you need it most, VXX is at its worst in tracking the VIX.

VXX may be even less effective as a long-term holding. As previously discussed, VXX suffers from negative roll yield when the VIX is in contango (when the front month VIX futures are less expensive than the second month futures), with the result that VXX loses a few cents each day due to rebalancing, just like a tire with a slow leak. This is why VXX is not able to sustain its value the way the VIX does. Thursday, for instance, the VIX closed at 28.27 and VXX closed at 52.35. Back on June 9, the VIX also closed at 28.28, yet on that day VXX closed at 74.26. That 29.5% drop in VXX while the VIX held steady is largely the result of negative roll yield – and is evidence that VXX is usually not viable as a long-term holding.

Comments

[Uday Maitra:]

The main issues with vol futures products is that you can't buy or sell the underlying, i.e. you can't arbitrage between the VIX and VXX etc. So all kinds of funny things can happen. A futures contract is the "expected future price", not really supposed to be reflective of the current spot. Similar funny stuff happened when the spot crude went to $140 etc, but futures traders kept on losing due to the rollover.

Oct 02 11:45 AM

[Baboon:]

To protect against market decline one needs just to sell calls on SPX.

Oct 02 12:43 PM

[PharmBoy:]

Is this rolling of futures contracts the same reason why UNG (recently) and USO (last year) do/did a lousy job of keeping up with the improved pricing of their respective commodities they track?

Oct 02 10:33 PM

[Schneidehouse:]

Why not just short it and let the 'slow leak' go to work for you?

Oct 03 10:03 AM