- July historically sees an increase in volatility. Does VXX?
- VIX futures are still in contango and the economic outlook is positive.
- Avoid the hype with this historical analysis.
In this article, we are going to look at a recent VIX commentary and compare that to a historical analysis of iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA:VXX). I will also give my outlook and present assessment.
For options strategies related to VXX, please check out my quick YouTube video here.
A twitter colleague of mine recently sent me a link to this video. In it, John Kicklighter, Chief Currency Strategist at DailyFX.com, goes over some historical VIX data. If you have time to watch the video, I recommend it.
Chart obtained from John Kicklighter, DailyFX.com.
Reviewing the information above, we can see that the majority of volatility gains occur between July and October. Specifically, as John points out in his video, volatility often sees a spike after the July 4th holiday. See below.
Chart obtained from John Kicklighter, DailyFX.com.
Now, John primarily focuses on the currency market. I focus strictly on the volatility market and the ETPs (exchange traded products) that follow them. At the end of the article, I will list all of the applicable ETPs you can use with this analysis.
My Historical Assessment of VXX
A great website for back testing data on many popular volatility ETPs can be found here. My question after watching John's video is, how would the volatility ETPs have performed, historically, after the July 4th holiday? For this analysis, primarily focusing on VXX, we will use the back testing data contained in the link above.
Chart created by Nathan Buehler using historical back testing data for VXX.
In the chart above, you see two separate results. On the left is the theoretical performance of VXX from on or around July 1st of the given year until on or around July the 15th. The data on the right shows the performance of VXX from on or around July 1st of the given year until on or around July 31st of that year.
Even though a spike in volatility is overdue, in my opinion, the historical risk/reward of this trade is not convincing. It is important to note that we have only gone back 10 years in our assessment. John's charts are based on the 20-year average. Back testing data is not available prior to 2004 for VIX futures.
Using the logic that you should invest in volatility just because it will historically rise would have proven to be unprofitable in VXX over the last ten years. In fact, if you held VXX for the entire month of July for the past ten years, your result would be a loss of over 78%. The largest gain would have come in 2007. This was arguably attributed to a declining economy rather than a seasonal trend.
My current assessment of VXX
As of 6/27/2014, here is where the VIX futures stand.
I have to be honest. After I watched John's video, I wanted to purchase some shares of VXX. However, after completing my research I would not recommend it. The VIX futures are still in contango, currently at 6.75%. This means that if the futures stayed the same price, at the end of July you could expect VXX to lose 6.75% in value. You would also need to factor in expenses of the fund. Theoretically, VXX would fall around 8%.
Given recent comments by Fed chair Janet Yellen, I am still bearish on short term volatility. The market has already priced in a rise in rates by the end of 2014 - beginning of 2015. If the Fed should delay a rise in rates due to any economic weakness, then I expect the markets to applaud and volatility to continue on in the low teens. The S&P 500 Index (NYSEARCA:SPY) is near all-time highs and some pundits have been calling for a pullback for some time.
As previously stated, I expect a spike in volatility over the coming months. This will simply be an emotional reaction to an event and not be supported by economic data. The U.S. economy continues to improve and the Fed has almost guaranteed that easy monetary policy is here to stay, for now. We also have no current, or in the immediate future, political events taking place. The next debt ceiling debate will come around March 16th, 2015. We have mid-term elections in November. Russia is quiet for now and we have not been involved (other than protecting our interests), so far, in Iraq. Over the last two years, the majority of spikes in the VIX have come from political, not economic, events.
Use the next spike in volatility, spot VIX range of 15-17, as an opportunity to go short on VXX. Assuming the economic and political outlook is bright.
I would personally avoid the hype about historical volatility increasing after the July 4th holiday. Using data from the past 10 years, we can see that would not have ended well for you. If you think you absolutely must purchase VXX now, then I recommend these hedging strategies here.
Below is a list of ETPs that perform similarly to VXX. UVXY and TVIX are leveraged 2x.
ProShares Ultra VIX Short-Term ETF (NYSEARCA:UVXY)
VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ:TVIX)
ProShares VIX Short-Term Futures ETF (NYSEARCA:VIXY)
As always, thank you very much for reading. Follow me on Seeking Alpha for regular updates on VIX ETPs. If you have any questions please feel free to message me directly or leave a comment below.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.