Wednesday, December 23, 2009

Reflections on VXX


I received a question regarding VXX, the VIX ETN, and its inability to accurately track the CBOE Volatility Index (VIX). For reasons I'll expound on at the end of today's post, the few times I have traded the VXX was to the short side. Rather than trying to reinvent the wheel, I'm going to cite a few posts from Bill Luby, purveyor of VIX and More, and someone who knows way too much about volatility.

In his post VXX Calculations, VIX Futures, and Time Decay Bill reviews various factors that hinder VXX's ability to accurately track the VIX.
As I type this, the VIX is up about 6.5% for the day and VXX is only up about 2.0%. While it looks like today is a good day to be long volatility, getting 4/13 of the move in the VIX with a VIX ETN does not look like an efficient way to play the volatility trade. In fact, I have discussed the issue of what I call the VXX juice factor on a number of occasions and have concluded that on average, anyone owning VXX should not expect to capture more than 50% of the move in the VIX, at least based on data since the January 30th launch of VXX. Going forward, however, 40% might be a more realistic target. A reader asked about the extent to which VXX returns may be adversely impacted by time decay, rolling and other issues...
Click the post title for the remainder. The second post I'd recommend taking a look at is titled Why VXX Is Not a Good Short-Term or Long Term Play.
...Unfortunately, VXX has considerable shortcomings, both as a short-term and a long-term play. Investors who are long VXX hope that when volatility increases dramatically, they will benefit by holding the short-term VIX ETN. In fact, when the VIX spikes 10% or more in one day, VXX generally does not cover even half of that move in percentage terms. The table below shows the eight instances since the January launch of VXX in which the VIX rose 10% or more in one day. The results speak for themselves, but in the eight instances over the course of eight months, VXX has been cpaturing only one third to two thirds of the VIX spike. Ironically, when the VIX is flat or falls, VXX does a much better job of keeping pace...
Although buying VXX has by and large been an exercise of frustration for those seeking bullish exposure in the volatility space, it is fair to say shorting the VXX has been a veritable boon for those using it to gain bearish exposure. The negative roll yield occurring when VIX futures are in contango has been a definite advantage to those short the VXX. At the end of the day, there's nothing wrong with simply staying away from the VXX if you don't understand it. Matter of fact, that's probably sound advice for any complex or exotic trading products out there. If I were to play the VXX I'd lean towards fading rallies, particularly if VIX futures remain in contango.

It will be interesting to see if VXX behavior improves when we get into an environment of an extended VIX rise coupled with VIX futures in backwardation.

For related posts, readers can check out: