Market Fears Flare Up: Volatility ETFs On Edge

by: Zacks Funds

The start of the New Year has been brutal for the global stock market with volatility levels at scary heights. The relentless slide in crude oil and persistent weakness in China are intensifying fears of a global slowdown, compelling investors to dump risky assets.

In particular, oil price tumbled to levels not seen in more than 12 years with Brent dipping to below $28 per barrel and U.S. crude being below $27 per barrel. Additionally, the spate of negative U.S. economic data, weak corporate earnings, geopolitical tensions, a strong dollar, slumping commodities, and sluggishness in other developed and emerging markets contributed to the woes. If the stock market slide persists, it could put a pause on the slowly recovering U.S. economy.

Volatility level is best represented by the CBOE Volatility Index (VIX). This fear gauge measures investor perception of the market's risk and tends to rise when markets are sliding or investor panic starts to set in. It is constructed using implied volatilities of the S&P 500 index options, taking both calls and puts into account.

The index climbed 12.8% in the past trading session and 48.3% since the start of the year, suggesting that risks are rising and investors could definitely benefit from this trend. While investors can't directly buy up this index, there are several ETF/ETN options available in the market that can provide some exposure to volatility. These products have proven themselves as short-time winners in turbulent times.

Below, we have highlighted short-term volatility products that will continue to move higher as long as the China-led deceleration and plunging oil price plague the global markets:

Simple Volatility ETFs

iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) - a popular ETN option providing exposure to volatility - sees truly impressive volume of about 71.5 million shares a day. The note has amassed $734.7 million in AUM and charges 89 bps in fees per year. The ETN focuses on the S&P 500 VIX Short-Term Futures Index, which reflects implied volatility in the S&P 500 Index at various points along the volatility forward curve. It provides investors with exposure to a daily rolling long position in the first and second month of VIX futures contracts. VXX jumped 9.9% in the past trading session and has surged 32.8% so far this year.

Two more products - ProShares VIX Short-Term Futures ETF (NYSEARCA:VIXY) and VelocityShares Daily Long VIX Short-Term ETN (NASDAQ:VIIX) - also track the same index. VIXY has $101.9 million in AUM and sees good average daily volume of around 3 million shares while VIIX is the unpopular of the two with just $11.4 million in its asset base and good volume of more than 271,000 shares per day. While VIXY charges 85 bps in annual fee, VIIX is costlier, charging 0.89% annually from investors. Both products gained nearly 10% on the day and are up 33% in the year-to-date time frame.

Another product - C-Tracks on Citi Volatility Index ETN (NYSEARCA:CVOL) - linked to the Citi Volatility Index Total Return, provides investors with direct exposure to the implied volatility of the large-cap U.S. stocks. The benchmark combines a daily rolling long exposure to the third- and fourth-month futures contracts on the VIX with short exposure to the S&P 500 Total Return Index. The product has amassed $4.6 million in its asset base while charging 1.15% in annual fees from investors. The note trades in good volume of about 167,000 shares per day and gained 16.4% in Friday's session. It is up 53.5% since the start of 2016.

The newly introduced AccuShares Spot CBOE VIX Fund Up Class Shares (NASDAQ:VXUP) was up 8.8% on the day and has surged 31.2% so far this year. It provides direct access to the spot price return of the CBOE Volatility Index, or VIX and charges 95 bps in fees per year from investors. The fund trades in a paltry volume of about 2,000 shares a day on average.

Leveraged Volatility ETFs

Investors seeking huge gains in a very short time frame could consider leveraged volatility ETFs. Currently, there are two options available in this category - ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY) and VelocityShares Daily 2x VIX Short Term ETN (NASDAQ:TVIX). Both products provide two times (2x or 200%) exposure to the daily performance of the S&P 500 VIX Short-Term Futures Index. Both gained over 20% on the day and are up more than 69% in the first few weeks of 2016.

Out of the two, TVIX is more popular with AUM of $446.5 million and average daily volume of 23.3 million shares. However, it charges a higher fee of 165 bps than 0.95% for UVXY.

Bottom Line

Investors should note that these products are suitable only for short-term traders. This is because most of the time, the VIX futures market trades in a condition known as 'contango', a situation where near-term futures are cheaper than long-term futures contracts. Since the volatility ETFs and ETNs like VXX must roll from month to month in order to avoid 'delivery', the situation of contango can eat away returns over long periods.

However, though 'volatility of volatility' is pretty high, this seems a good time to remain invested in this market.

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