One of the first things that anyone paying attention to VIX and its related products notices is the discrepancy that you see in daily movements. Depending on the market environment it is not unheard of to see spot VIX green for the day but VXX, UVXY and TVIX red for the day. While confusing to many, this is not a reason to get upset with the performance of your volatility product.
Just as one would not get angry at their car for not performing well as a submarine, you can't be upset that VXX is not tracking spot VIX on a performance basis. As we covered in the first article in this series, VXX and other short term volatility products are priced based on the performance of a mix of the front and next month volatility futures.
This is done because all short term volatility products are meant to forecast the level of volatility in the next 60 days. By maintaining a changing level of front and next month contracts, the providers of VXX and its cousins are attempting to mirror that level of volatility in the markets for that time period. Since spot VIX is the market's expectation of volatility in the next 30 days, you can see why there will always be a disconnect between spot VIX and any short term VIX product. At some point you end up comparing apples with Studebakers.
Case In Point
The trading action on Monday, July 30 provides a great example of this in action.
Spot VIX: +7.19%
At first glance, you see that spot VIX moved up more than 7% while VXX, UVXY and TVIX seemingly underperformed on the day. We have to remember that none of the products on the market today allow us to trade off of spot VIX and that all short term volatility products trade off the performance of the futures contracts. Looking at the VIX term structure for the day, we find the following:
Spot VIX: 16.70 to 18.03 (+7.19%)
Aug Futures: 18.6 to 19.50 (+4.84%)
Sep Futures: 20.65 to 21.22 (+2.76%)
Ok, since VXX right now is about 50/50 Aug/Sep futures, we are much closer to the average movement of the two futures at 3.8%. To account for the difference between this average and VXX's performance of 2.16%, we can attribute that to the cost of rolling front month futures into next month futures over time. As we get closer to the VIX August futures expiration date, the August futures are sold and September futures bought, which causes a daily roll cost due to continued Contango. If the VIX futures enter into Backwardation, this will switch from a daily loss to a daily gain and will reward those holding long volatility products.
As for the disconnect between TVIX and UVXY, well, I have already stated my opinion on TVIX as a tool to trade volatility. I believe that the share issuance halt has fundamentally broken TVIX as a trading tool and would not recommend using it, as it no longer trades in a predictable manner. Once your ETF or ETN ceases to function as advertised, I recommend moving to another implement. Trading volatility is already difficult enough, don't make it harder by trying to predict whether Credit Suisse will pull another fast one in the future.
This one day's worth of action in the volatility markets gives us an excellent snapshot of why one can't look at spot VIX alone and must remain cognizant of the underlying VIX futures term structure.
Just as you wouldn't expect your lawnmower to paint your house, you can't expect VXX and the other short term volatility products to mirror the moves in spot VIX.