Why VIX ETPs Have Been Underperforming

Includes: TVIX, UVXY, VXX
by: Barath Balu

Many of you who invested in various VIX related exchange traded products may have noticed that they have been underperforming the actual VIX by a wide margin. For example, while the VIX has fallen roughly 10% since March 3rd, the exchange traded products(ETPs) that track the VIX, such as TVIX, UVXY or VXX have declined about 57%, 56% and 31% respectively. TVIX and UVXY are both double leveraged funds but VXX is unleveraged so it stands to reason that the changes in TVIX and UVXY are about double that of VXX. However, even while accounting for leverage, all these funds underperformed the VIX by about 20%. To understand the reason behind this divergence, we must first examine the true nature of these VIX funds.

A common misconception investors have regarding VIX ETPs is that they somehow actually invest in the VIX. In reality, VIX ETPs invest in VIX futures of varying terms. The VIX ETPs in question (TVIX, UVXY and VXX) all track short term VIX futures, meaning 1-3 months until maturity. The funds accumulate new contracts daily, focusing mainly on the nearest maturity contract. This method would, under normal circumstances, produce returns that are proportional, or at least closely related, to that of the VIX, but the VIX futures market is suffering from a phenomenon known as contango.

Contango is when the actual price of a futures contract is higher than the expected spot price of the contract at maturity, which, in the case of the VIX futures market, has been true for a couple months now. The chart below shows the price of both the April 12th futures contract and the spot VIX over the last month. As you can see, the actual spot price of the VIX during March was fluctuating around 15. Futures, on the other hand, were trading as high as 22.08.

The gap between the two curves, depicting the premium one pays for the futures contracts at any given date, is widest at the earliest dates. However, as time progresses, we see the gap between the two curves diminishing, becoming almost insignificant when they approach the maturity date. The graph below shows the change in the premium over time.

The premium fell from almost 50% to 1.5% just before the contract matured. Consequently, the ETPs which invested in these contracts have lost a great deal of value. In fact, although the spot VIX has increased 25% since March 12th, the price of the futures contract and the ETPs have fallen because they have had to shed that premium.

The bottom line: VIX ETPs are terrible long term investments right now, as they will severely underperform the spot VIX. The best and arguably only way to invest in these ETPs is to accurately time fluctuations in the VIX. Therefore, it is highly recommended that all but the most experienced of investors avoid investing in securities such as TVIX, UVXY or VXX.

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