VXX And High-Frequency Trading

Apr.16.14 | About: iPath S&P (VXX)


VXX is for traders, not investors.

The underlying entity can easily be manipulated.

This is probably the most targeted ETF by High-Frequency Trading.

The most manipulated ETF on the market is not a small cap ETF like IWM, a sector which is typically riddled with manipulation, but instead it is found in a niche that is not really considered an investment anyway. That ETF is VXX, and it is the most manipulated ETF on the street.

By definition, investments are something that people can put their money in and the potential growth of the underlying entity could offer them an excellent return on investment. That then makes the underlying entity important to consider, especially when dealing with ETFs. If the underlying entity is a stock or group of stocks, the evaluation would be based on the potential for that stock or group to grow. If the underlying is something else, like options or futures, more than just growth comes into play.

Specifically, spread risk, which is also part of deterioration risk, plays a significant role for any ETF that invests in options or futures. Anyone can see that the percentage spread between a stock's bid and ask and the average bid and ask of an option contract is different. The percentage for the option contract is much larger usually, and if that contract is not liquid, it could be a significant difference as well.

That means, if you bought and then need to sell that option contract immediately thereafter, you could lose meaningfully without anything else changing. It is like buying a new car; as soon as you drive it off the lot, you have lost money. Well, in many cases, because option contracts have wide spreads between the bid and ask, if nothing changes, the difference is what you lose if you buy and then have to sell again immediately. There are other variables, of course, but that explains the spread risk, and sometimes spread risk can exceed 10%.

However, the underlying entity we are discussing here is highly liquid, so the spread risk is not that significant at first glance, but still, it exists, and it is that which enables market makers to manipulate the underlying entity of the ETF in question. For example, if they know money is coming in, and that is obvious in large volume ETFs, market makers can adjust bid and ask to better their own pocketbooks.

That is exactly what makes VXX a horrible investment. Not only does it invest in options that have natural deterioration risk, but it also is highly manipulated.

According to our real time trading report for VXX, this ETF has not tested longer-term support yet, its longer-term channel is very weak, and aside from an intra channel level of support, there are no immediate trading catalysts. A solid trade could come if VXX drops to mid-term support, but that would only be a trade, not an investment.

In VXX, there are no investment signals whatsoever, but VXX is not an investment anyway, because the underlying entity is an option, and that option has natural deterioration risk. That deterioration risk is also exaggerated by High-Frequency Trading, and the manipulation that takes place by market makers.

I know VXX is very liquid, it moves like the wind and it is great to trade, but investors need to stay away. This is not an investment. Investors should avoid VXX at all costs.

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

Business relationship disclosure: By Thomas Kee for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.