VXX Outperforms The VIX

by: Surly Trader

There are numerous articles on the profitability in shorting the iPath S&P 500 VIX Short-Term Future Exchange traded note, VXX. Some investors who thought this was a fool-proof strategy will be scratching their heads about the stellar two month performance of VXX:

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VXX outperforms the VIX.

The key performance reasons have been 1) rising levels in all of the VIX futures contracts and 2) the movement from contango to backwardation.

When the VIX futures curve is in contango, the VXX ETN continuously buys a futures contract that ages, rolls down the curve, and loses value. When the VIX futures curve is in backwardation the opposite process happens – the ETN buys a futures contract that ages, rolls up the curve, and gains value.

By looking at the last two-month spread between the fourth month and one-month VIX futures contract, we can see that there has been strong backwardation since the beginning of August:

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Backwardation shown in the VIX futures spread between one month and four month.

The good news if you are short: These periods of backwardation have always reverted to contango in the past and there is no reason that we should expect this time to be different.

Volatility cannot stay at 45% because there would be very few equity investors left to trade if daily moves were expected to be in the 3%+ range. Even the black boxes need investors to backstop their losses.

Disclosure: I am short VXX.