Beware the Wrath of VXX
This should be a statement of the obvious, but a week doesn’t go by that I don’t see someone extolling the virtues of VXX as a free lunch (so perhaps it’s worthwhile to beat this dead horse once more)…
Below is a graph of VXX since inception in 2009:
For two years, VXX has been on a march towards zero. For those keeping score that’s a -93% return since inception, and on first blush, looks free lunch sexy for shorts.
But VXX’s death march is a result of market fundamentals that are by their nature temporary, and when (not if) big volatility/backwardation returns, the wrath of VXX will devour the shorts whole.
Below is the S&P 500 VIX Short-term Futures TR Index, which VXX tracks, back to 12/2005 (giving us 3+ years additional data):
The period since the ETF VXX launched is in grey and all prior data is in red. It’s clear from this second graph that VXX was the beneficiary of very fortuitous timing.
Note the spike that would have occurred in VXX during the financial crises in late 2008 – that’s a 300% gain (loss) for longs (shorts) in the space of 3 months.
The point of this post is not that trading VXX short is bad. I take short VXX (or more accurately, long XIV) positions in my own vol trading.
The point is that VXX is not a free lunch, and that when volatility and the VIX term structure inevitably turn, shorts need to be prepared to quickly let go of this beloved trade.
Happy Trading,
ms
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Filed under: VIX & Volatility | 6 Comments
I think the majority of the VXX losses are a result of the constant contango the VXX is in, and not the reduced volatility we’ve seen in the past years and months. The VXZ with its focus on longer contracts seems to have less problem with contango.
Hello Aleco – I agree with you and I’ll be showing that in tomorrow’s post.
One note however: you can’t totally separate volatility and the term-structure. Generally speaking, with big volatility has come backwardation and with tempered volatility (i.e. today’s market) has come contango, so to a large degree, the contango VXX has suffered from IS indirectly a result of the reduced volatility over the last years and months. michael
One other problem is that as the ETN books losses the absolute number of contracts the ETN buys goes down so the leverage to the VIX effectively decreases as the negative roll yield destroys NAV.
Can you explain why before the 1 for 4 split in shares the VXX had decent correlation to the VIX and since is hugely not correlated it seems. The VXX was trading about 48 (12 presplit) Nov 12,2010 and i think the VIX about 19. The VXX is now 24 (6 presplit),50% lower and the VIX is 26 (40%) higher.
RE to kkmusicman: because VXX (and XIV, etc) are in no way a pure VIX tracking mechanism. These instruments track the VIX +/- the impact of the VIX futures term-structure (in addition to some other less significant factors). michael