Schaeffer's Trading Floor Blog

A Tale of Two Volatility ETNs

A poetic look at two exchange-traded notes (ETNs)

by 1/24/2013 8:00 AM
Stocks quoted in this article:

It was the best of times,

VelocityShares created a phalanx of volatility-tracking exchange-traded notes (ETNs) back in late 2010. Far and away that best of the lot was the VelocityShares Daily Inverse Short-Term ETN (NYSEARCA:XIV). Its mission: track the inverse of the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX). Tracking ETNs lose money over time… except when they track the inverse of something that acts very poorly. The XIV listed at a split-adjusted price of $10. It's now over $22.

it was the worst of times,

Well, there's VXX itself. It listed at a split-adjusted price of $1,600 almost exactly four years ago. It was a split-adjusted price of around $200 when XIV listed in late 2010. VXX has a perfect game going in 2013. It has hit all-time lows at some juncture of every single day.

it was the age of wisdom,

XIV has lifted 35% already this year. Eric Jackson of Forbes had a survey at the end of last year and asked us for one long idea and one short idea for 2013. XIV was my long idea, so I'm a genius, right? Well, not exactly...

it was the age of foolishness,

My short idea was Research In Motion Limited (USA) (NASDAQ:RIMM). It's up 46% so far in 2013. In my defense, I haven't shorted a non-index in real life in just short of forever; it's just not something I do. I just went with "what's the worst company you can think of?" But wow, what a terrible pick on my part. I believe in 2012 I had McDonald's Corporation (NYSE:MCD) as my long and Panera Bread Co (NASDAQ:PNRA) as my short, based solely on the fact that I like the food deal at MCD better. That call was awful.

If I'm asked back, go long whatever I pick as my short.

it was the epoch of belief,

No matter how relentless the decline in VXX, I get tweets and DM's asking about going long. It's getting hit by a combo of CBOE Market Volatility Index (VIX) drifting to multi-year lows and the relatively steep contango in the near-month VIX futures. As long as you think of VXX as a trading vehicle only, by all means, take a stab. Just keep your time horizons VERY short. VXX acts like a basic index put. It generally declines when VIX declines, and it also declines when VIX churns, thanks to the contango in the VIX futures. Think of that latter part like you would think of time decay on a basic put option. If you buy VXX and catch a turn in VIX, terrific. Just know that time is money in VXX, so if you buy and have to sit and wait for a turn, the price is going to dribble down.

it was the epoch of incredulity

Another angle on VXX is, "How did the SEC allow this thing to begin with?" Frankly, I'm not sure. They've added disclaimers over time, but I'm pretty sure very few actually read them. They see VIX at 12 and want to fade it somehow. Which, obviously, isn't a bad thought. I'd simply rather use relatively cheap Real Actual Live Old-Fashioned put options to play it, something like modestly out-of-the-money SPDR S&P 500 ETF Trust (NYSEARCA:SPY) puts with two to four months until expiration. Not saying I've actually done that, but if I was of a mind to buy protection or speculate on a drop, that's what I would rather use.

… it was the spring of hope, it was the winter of despair.

Well, if you're long anything volatility-related, it's very much the winter of despair. But hey, there are always those March shakeouts! Again though, time is money. You're often better off missing the actual turn.

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


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