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VXX - Profiting where others fail

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

It has been widely discussed how poorly the VXX has performed versus the VIX index.  The product is inherently flawed due to the nearly constant contango of the first and second month futures. 

As a refresher, contango occurs when the futures curve is upward sloping (near months cheaper than distant months).  Any product which requires rolling front month futures to next month faces a severe cost each month.  We have seen this in USO, UNG, and VXX causing these ETP's to massively underperform their spot index.

Here are some statistics to highlight the point.  Since 3/26/2004, there have been 1737 trading days in VIX futures.  On 350 days (20.1%), the roll had a POSITIVE yield meaning that front month VIX contracts were trading above next month.  This would be good for VXX holders in that they would be selling higher priced futures and buying lower priced futures thus getting more futures for the next period.

But this happens only 20% of the time!  The other 80% of the time, the ETN pays to roll their position.  On average, including the positive yield days, it costs 5.1% PER MONTH to hold this position.  That does not include futures commissions and spread costs, not to mention Barclay's 89 basis point yearly fund fee.

So investors on average can expect to lose 60% per year (non-compounded) to hold this big ugly.  In fact, in the funds 23 months of existence, it has lost nearly 90% of its value.  It will continue unabated.

Now, how to profit from this beast. If an asset is constantly wasting away, the best way to make money is to short it.  VXX is hard to borrow so a direct short will be difficult.  Selling listed calls is the answer.

Take a look at the June 50 Calls.  With the VXX trading at $45.4 as I write this, the calls are $8.30 bid.   That is $8,300 of premium for selling 10 calls.

There are 7 months until expiration which at a negative 5% per month, suggests that the VXX should wither to around 29.5 (down 35%).  Even with a large spike in volatility (which tend to be short term in nature), it is unlikely the VXX will be in the money at expiration. 

Most traders and gamblers would consider good odds anything that gives them a small edge in a bet or trade.  The VXX is handing you 80% odds that the ETN will be lower in 7 months! Remember, statistically the VXX is in contango 80% of the time. Talk about edge!  It doesn't get much better than this.

Yes there is risk that a short term jump in volatility could cause this trade to go negative and inflict losses on this strategy but if you can be patient and hold this until expiration, the odds are massively in your favor.

Disclosure: Short June 50 Calls