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Backward Simulation For Volatility ETNs (2006-2011)

|Includes:TVIX, iPath S&P 500 VIX Short-Term Futures ETN (VXX), VXZ, XIV

One of volatility traders I met, dd2020dd, recently discuss about is there any volatility-drived ETN designed for holding in long-term ? This is also a question in my mind for a long time. It's said considering (1) credit risk, (2) market risk, (3) liquidity risk, (4) price tracking risk and (5) early redemption risk and compounding risk, any prudent investor should not hold those ETNs for more than 10 days. However, if you do want to take risk , what should you pick with best shot ?

Below is the display of S&P 500 constant-maturity indices

underlying four major ETNs: the VXX (Blue), VXZ (Green), XIV (Red) and TVIX (Light blue). You could find this chart in the paper "Understanding ETNs on VIX Futures " written by Carol Alexander and Dimitris Korovilas in ICMA Centre, Henley Business School at Reading and you can find here . These indices were first quoted in December 2005 (till Dec. 2011), starting at a value of 100,000. Interestingly no ETN issuers provide this chart inside the prospectus, if they did, retail investors should think twice before put money in.

(click to enlarge)Click to enlarge

If we update the chart to 13th July, 2012, we could find XIV is the only vehicle with significant gain (around 68% gain) for holding 6.5 years, which significantly beat SP500 index performance for the same period of time. Not surprisingly, the contango effect does erode TVIX, VXX & VXZ most of time. While VXZ still log mild gain or loss (less than 10%) over 6 years, due to the huge jump during 2008 crisis.

I can't agree more with the dd2020dd's conclusion: Although it's much like taking financial roller coaster, combined with contango over 80% of the time, makes an inverse volatility product like XIV the logical choice for a long term trading alternative and provide you the best shot in volatility universe. If you happen to time the market well, inverse volatility product might even provide some decent gain.

Disclosure: I am long XIV.