What to Make of the Unprecedented VXX Action in 2018

VXX has experienced a rare bullish stretch to start the year

Mar 26, 2018 at 10:15 AM
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The following is a reprint of the market commentary from the April 2018 edition of The Option Advisor, published on March 23. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month --  visit our online store.

We haven't quite put a full calendar quarter in the books yet for 2018, but it's not too early to observe that the action this year in the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) has been unprecedented.

Over the course of this nine-year bull market, the exchange-traded note (ETN) -- which derives its value from a rolling long position in first- and second-month Cboe Volatility Index (VIX) futures -- has become best known for its pronounced long-term downtrend (as much a product of the market's low-volatility uptrend as its own daily rolling mechanism), as well as the multiple reverse splits it has undergone to stave off the descent toward zero.

According to an analysis of monthly returns by Schaeffer's Quantitative Analyst Chris Prybal, the January-March quarter is typically a bleak time for VXX. Since inception, the average January return is a loss of 4.7%, while February yields a 7.8% drop. March, meanwhile, is the worst month of the year for VXX, with its average return ringing in at a steep 14.9% decline. Even considering the fact that long-time underdog VXX manages a positive average return in only one month out of the calendar (August, to be exact), it's a remarkably poor three-month stretch.

But in 2018, the VXX narrative has flipped. The ETN, which ended 2017 at $27.92, notched a monthly gain of 7.3% this past January (the entirety of which was racked up over the course of the final three trading days of the month, incidentally).

From there, the ongoing ramp in equity volatility forced VIX futures into a relatively rare state of backwardation, which resulted in an equally rare scenario where VXX's daily roll into longer-dated VIX futures transformed from a handicap into a boon. By the time the dust settled on the month of February, VXX had vaulted to a gain of just over 48% -- bringing its year-to-date gain for 2018 to 58.9% through the first two months of the year.

Excluding 2009, when VXX made its debut just in time to catch the final trading day of January, there has been only one other year when VXX was positive in both January and February -- 2016. With its high-volatility sell-off in stocks to start the year, 2016 was not too terribly dissimilar from the current year, although the VXX logged the larger monthly gain of 20% in January of that year before adding "only" 3.2% in February.

vxx monthly returns 2016

It was a quick trip lower after that, as VXX settled March 2016 on a monthly drop of more than 29% (outpacing even its own woeful average March return). And simultaneous with VXX's fast and furious reversion to the mean, the SPDR S&P 500 ETF Trust (SPY) went on to close March 2016 comfortably higher, up 6.2%.

Notably, the unusual January-February surge in 2016 presaged a fairly complete breakdown in VXX's "typical" monthly seasonality through the rest of the year. As noted above, August is the only month where VXX has averaged a positive return, to the tune of a substantial 13.8% since inception. But in 2016, after rocketing higher to start the year, VXX went on to close that August down 11%. The ETN's only positive monthly returns that year occurred in June, coincident with the Brexit shockwave that rippled through global markets, and in October, as pre-election anxiety in the U.S. was peaking.

While 2016 was somewhat comparable, 2018 is unique in that VXX has never before been up more than 50% year-to-date through the end of February. In fact, aside from the "incomplete" VXX year of 2009, there have been only two years where VXX has been higher on a year-to-date basis through two months -- 2014 and 2016. In both years, VXX went on to rack up hefty percentage declines over the March-December period, while SPY tallied double-digit percentage gains.

vxx march-dec returns after jan-feb rally

Broadening the scope of our analysis beyond simple monthly returns, VXX is (as of this writing) ensconced in an unusually lengthy streak above its 160-day moving average. While VXX has yet to challenge its 320-day moving average during this "Great Volatility Ramp of 2018," the ETN has now notched more than 30 successive daily closes atop its 160-day trendline.

There have been only four other occasions since 2011 where VXX has lingered so long above its 160-day, as shown in the tables below. In most instances, VXX exceeded its average "anytime" losses over nearly every time frame, with the six-month returns yielding especially steep drops. And while SPY returns going forward after one of these "VXX 160-day streak" signals were somewhat unpredictable over the shorter term, the equity tracker resoundingly surpassed its own anytime returns at the six-month and one-year marks following the 2011 and 2016 streaks.

vxx and spy returns after 160-day MA streaks

Stock market bulls, of course, will be hoping that this latest signal plays out like those in 2011 and 2016, and not like the 2015 signal that preceded notable SPY underperformance over every time frame. And those traders should therefore be very interested in what appears to be a descending triangle pattern forming on the VXX daily chart. This formation most often heralds an imminent continuation of the prevailing downtrend, but a VXX break above that descending trendline would be cause for concern.

vxx 160-day descending triangle


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