Volatility Pops: The Exception to the Rule

The staggering returns of volatility ETFs are hard to catch

Oct 20, 2014 at 8:29 AM
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This panic about a CBOE Volatility Index (VIX) contagion has gone too far! I hereby graciously accept the position of VIX Czar. OK, so I appointed myself -- there was a power vacuum and I stepped in to fill it.

For my first act, I am going to send an intern out for iced coffee. What's that you say? No interns? What kind of budget does my new cabinet-level department have, zero? OK, it really does have no budget. Oh well.

Anyway, for my first act, I would like to remind everyone that the recently staggering returns in volatility ETFs are way more the exception than the rule. They truly were staggering, though. The iPath S&P 500 VIX Short-Term Futures ETN (VXX) closed at 29.55 on Oct. 8. On Oct.16 it peaked at 44.60, very near the open. That's a 50% pop in basically a week.

The news was even better in the VelocityShares Daily 2x VIX Short-Term ETN (NYSEARCA:TVIX), as you might expect, considering TVIX tracks 2x VXX. It closed at 2.89 on Oct. 8, then peaked at 6.15 on Oct. 16.

If you caught any of that, many congrats. It's moments like these that show why it's extremely risky to sit short on any of these pups. And, that includes shorting on the way up to try to nail a top. But, I'm ordering my unpaid staff to remind everyone that past performance of the last week does not predict future returns.

Even though VIX is way down from its own highs on Oct.15, it's still up about 60% in 2014. VXX, on the other hand, is actually down on the year. It closed 2013 at $42.55. Yes, that's correct. It's still down in 2014 despite a surge in the last week and a year that at the moment has worked quite well for VIX itself. But at least VXX wiped out its losses in 2014, however briefly. TVIX closed out 2013 at $7.50, so it peaked well short.

VXX, as I hope you know, proxies a 30-day VIX future. And, with futures generally in contango and at a premium to VIX itself, that costs it money every day. The script did flip recently as near-term VIX futures went into backwardation, but ironically those ostensibly favorable conditions occurred right as negative market sentiment was peaking. That is, it took pretty extreme and unsustainable negative sentiment to get VXX into a spot where its structure actually worked to its advantage.

VXX didn't exist yet in 2008, but you really need that kind of never-ending volatility pop to keep it heading north.

Anyway, I want to end my first day as VIX Czar with this reminder: VXX -- and TVIX, and its less evil twin, the ProShares Trust Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY) -- are purely trading vehicles on the long side. If you can catch a move, terrific. But, don't sit with them for any important length of time.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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