Schaeffer's Outside the Box Blog
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It was a pretty ugly week in the markets, as the S&P 500 Index (SPX) dipped about 3% at its worst. What's more, we have a relatively flat term structure in the CBOE Market Volatility Index (VIX), at least in the nearer terms.

So, it sounds like boon times for the VIX ETN complex.

Well … not so much. This, from Bill Luby:

In examining the graphic below, the first thing you probably notice is that only 5 of the 19 VIX ETPs were able to manage gains during the selloff. In fact the average (mean) VIX ETP performance was a disappointing -4.9%, while the median return was -6.7%. Even more interesting, the inverse volatility products actually outperformed their long volatility counterparts and had the top performer of all, the VelocityShares Daily Inverse VIX Medium-Term ETN (ZIV).

Ouch. Perhaps the flattening in and of itself hurt performance? Or perhaps not:

In addition to the static allocation long and short volatility ETPs, there are also three products that use rules-based formulas to dynamically allocate the amount and type of long volatility exposure: VQT, XVZ and VIXH. None of these three products was able to produce a profit during the selloff and the top performer among the group, VQT, managed a loss of 3.4%.

On the surface, this is all pretty discouraging. You own a VIX product precisely because you expect it to hedge your portfolio or give you a nice profit on a downside move in the market. But should we have expected this latest wave of underperformance?

Well, the VIX was elevated a bit ahead of the uncertainty of the election. It's hard to convince too many people that a VIX in the high teens is any sort of elevation, but if our New Normal is a low-VIX regime, then moves into the high teens and low 20s may actually mean just that.

Once news comes out -- say earnings, for example -- implied volatility does tend to contract, even if the news disappoints and the stock declines. So perhaps that's what happened here. Implied volatility was bid up further than we all perceived into the election, and the hypothetical decline off that was offset by the decline in the actual market.

Sounds plausible in regards to the VIX, but it doesn't really explain the punk performance in the tradable VIX products. No matter the structure, they all price forward in one way or another, and any forward-pricing vehicles will mostly ignore very short term "noise" in volatility. So even if this theory of VIX as a sort of earnings reaction holds, it doesn't necessarily explain the VIX trading complex.

So what does explain it, then?

Well, they were a bit overpriced over the course of the summer, especially out in time like the 4-7 month duration that the iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ) covers. And now those premiums have severely contracted to what most would define as fair levels.

Instead of asking why it all seemed to happen at once, maybe we should just look forward and say, well, it's a much better time to use VIX ETNs to hedge or speculate on now than it was one, two, or even three months ago.

Disclaimer: The views represented on this blog are those of the individual authors only, and do not necessarily represent the views of Schaeffer's Investment Research.

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