Surge in Volatility ETF Trading Highlights Market Unease

by: Tom Lydon

Exchange traded funds that profit from rising market volatility remain elevated along with the CBOE Volatility Index as investors remain nervous over the global recovery, U.S. credit downgrade and Europe’s debt crisis.

The VIX has surged to the highs from 2010 but remains below the 2008 spike from the credit crunch.

Volatility is alive and well, and some analysts are warning that investors should get used to it.

The VIX did pull back on Tuesday after the Federal Reserve tried to soothe markets with a pledge to keep interest rates low until mid-2013. Stocks rallied Tuesday as the Dow gained more than 400 points.

“The spike in the VIX above 30 last week signaled a transition…This phase of the cycle will end once VIX has descended back through the 25 level, which we would interpret as an all-clear sign for equities. In the meantime, we expect the most turbulent and unpredictable period of the volatility wave will play out over the next couple of weeks,” said Jim Strugger for MKM Partners, on Barron’s.

The VIX surged 50% on Monday, then Tuesday, dropped 27% to 35.06. The VIX is a measure of implied market volatility based on S&P 500 options.

The iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) fell 10.1% on Tuesday in response. However, the exchange traded note was up more than 3% as Dow futures pointed to a lower open in U.S. stocks.

Exchange traded products track VIX futures contracts, rather than the spot price.

VIX futures expiring this month fell 17% on Tuesday. The S&P 500 has fallen about 11% over the past few days as the markets absorb the gash to the U.S. debt rating, and while Europe continues to grapple with the sovereign debt.

iPath S&P 500 VIX Short-Term Futures ETN

click to enlarge

VelocityShares Daily 2X VIX Short-Term ETN (NASDAQ:TVIX)

Chart source:

Tisha Guerrero contributed to this article.

Disclosure: None