Volatility ETN Can Help Decision Makers Act Rationally [Podcast]

May.22.12 | About: iPath S&P (VXX)

Not every exchange-traded investment is a sensible core holding. In fact, some may not even work particularly well as trading vehicles. In many instances, this is the way that I feel about volatility ETFs/ETNs.

Volatility ETNs have been a nightmare for buy-n-holders. Many have seen their principal erode 30%, 40%, even 50%. And yet, the iPath S&P 500 VIX Short-Term Futures (NYSEARCA:VXX) has demonstrated utility as a predictive tool.

Consider the two worst bear scares in the current 3/2009-5/2012 bull market. The first came in late April of 2010. A steep 16% top-to-bottom decline essentially ended in the first week of July, 2010. The second came in late July of 2011, when the U.S. government failed to agree on a debt ceiling deal and S&P downgraded U.S. treasury debt. The devastating 19.5% top-to-bottom sell-off effectively ended in the first week of October, 2011.

Now consider the times when the iPath S&P 500 VIX Short-Term Futures (VXX) definitively broke through its 100-day moving average to the upside. You guessed it ... in late April of 2010 and July of 2011. What about when VXX descended definitively below its 100-day trendline? July of 2010 and November 2011. Not too shabby.

Click to enlarge

VXX 100 Day TrendlineClick to enlarge

So here is what I propose that a self-directed investor think about. Maintain a high-yielding ETF portfolio (sans international) like the one that I delineated in my previous post, “Hate The Sell-Off?” (The drawdown is roughly half that of the S&P 500). However, if VXX closes definitively above its 100-day moving average, use the event to sell a significant percentage of stock ETFs in your portfolio.

Granted, VXX is hardly the only tool for deciding how and when to lighten up on risk assets. It does not have the world’s lengthiest track record either.

By the same token, the European sovereign debt crisis didn’t become a mind-boggling market concern until 2010 either. It follows that ... for as long as flare-ups in the European Union have dominated the mindsets of institutional traders ... the price of VXX relative to its 100-day trendline has been particularly telling. What’s more, it’s an unemotional means for protecting against disaster.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.