VXX (and TVIX, etc.) for Dummies
Originally drawn on the back of a napkin to explain to a fellow why the long VXX/TVIX play was silly in this market, and I thought it worth reproducing here…
Some still don’t grasp the idea that the long VXX (and TVIX, etc.) trade is a horrible way to play an expectation of rising volatility (when VIX futures are contangoed, which they usually are).
The cheat sheet above is about as simple a way as I could think of to explain why.
Nobody (and by “nobody” I mean NOBODY) knows with certainty where the market is going. The best we can hope to do is put the odds in our favor.
And the cheat sheet shows why betting against the VIX futures term-structure (ex. long VXX when futures are contangoed) stacks the odds against you.
If futures are contangoed and you’re right that volatility will rise, you will likely profit. If you’re wrong, you will lose. Fair enough.
But if volatility neither rises nor falls significantly, you will also lose. And that’s why the odds are stacked against you.
Unlike buying a stock where the possible outcomes are: win, break even, or lose, here our possible outcomes are win, lose, or lose more. If this were Vegas, you’re choosing to be the gambler instead of the house.
So no more “long VXX/TVIX because volatility has to increase” talk please. That’s an opinion much better expressed with other instruments that are not actively working to destroy your hard earned trading capital.
Note: none of this necessarily applies to using VXX to hedge a portfolio. While I don’t particularly like that idea either, it makes a lot more sense than making an outright bet against the VIX futures term-structure.
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Filed under: VIX & Volatility | 15 Comments