Investors can utilize CBOE Volatility Index, or "VIX," linked exchange traded notes to hedge against sudden market swings. However, the investment strategy should not be used as a long-term position.
Robert E. Whaley, credited as the architect of the so-called fear index, stated that VIX ETNs are "not suitable buy-and-hold investments" and are "virtually guaranteed to lose money through time," reports Brendan Conway for Barron's.
Whaley points to funds like the iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA:VXX), VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ:TVIX) and ProShares Ultra VIX Short-Term Futures (NYSEARCA:UVXY).
Volatility-linked products are designed to track VIX futures rather than the spot price. An investor can't actually buy the VIX, but anyone can gain access to the Index through ETFs.
Due to the way the ETFs are structured, losses are compounded when VIX futures are in a state of "contango" - longer-dated contracts are more expensive than the front-month contract. As the fund rolls front-month contracts, the ETF sells the maturing contract and purchases a more expense later-dated contract, which could diminish returns over the long run.
The "negative roll yield" reduced VIX ETF returns by as much as 30% in a month in early 2012.
Nevertheless, investors should not be using these funds as a long-term, buy-and-hold allocation. Whaley refers to VIX ETFs as a "trading vehicle," and investors can still use VIX funds to hedge against short-term volatility or aggressively capitalize on uncertainty, such as in the week ahead of the government default deadline.
Max Chen contributed to this article.
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. I have no business relationship with any company whose stock is mentioned in this article.