VXX’s Brief Moment in the Sun

24Apr13

Random thought for the day…

I (humbly) disagree with folks who poo-poo VXX (long 1-month VIX) as a bad investment.

Let me rephrase that. I think it’s very worthwhile to educate investors about why buying VXX is usually a bad choice (read more), and why buying VXX for the long-term is always a bad choice, but VXX isn’t in and of itself broken. It’s just an investment whose brief moment in the sun hasn’t come yet.

Investors would be forgiven for losing sight of that. Behold the horror show that has been VXX since inception in 2009:

20130424.01
[growth of $1, logarithmically-scaled]

But there’s a lot more data to consider than most realize. Recall the graph below that I’ve shown previously estimating VXX back to 2004, adding an additional 5 years of data prior to the ETF launch (1).

20130424.02
[growth of $1, logarithmically-scaled]

Some notable VXX runs: a 97% gain within 2 months (2007), a 183% gain within 3 months (2011), and the big daddy, a 336% gain within 3 months (2008).

The problem is of course that investors too often try to trade VXX by timing the market. They preemptively buy VXX when the market gets overbought, and then get decimated by the water torture that is contango if the market does anything but go straight down.

A much better approach is to let the state of the VIX futures term-structure (i.e. backwardation) be the guide as to when VXX might be a viable play, and then (and only then) attempt to time the broader market.

That day will come, because the return of big volatility is necessary and inevitable. And when it happens, investor darlings like XIV (inverse 1-month VIX) will get crushed. Contrary to what is becoming conventional wisdom, XIV is only slightly more appropriate as a blind long-term play than VXX is.

To illustrate, the same extended historical data set for XIV back to 2004:

20130424.03
[growth of $1, logarithmically-scaled]

The difference between them is that XIV is usually the wise choice, but when it’s a bad choice, it’s really a bad choice. Flip that on its head for VXX. VXX is usually the unwise choice, but when it’s the right choice, it’s really the right choice.

VXX isn’t broken, it’s just an investment whose next brief moment in the sun hasn’t come yet.

Shameless self-promotion: to see MarketSci’s own approach to timing VXX and XIV, check out our Volatility ETF Strategy.

Happy Trading,
ms

(1) VXX data through 12/2005 estimated based on VIX futures, through 01/2009 based on the underlying VIX Short-Term Futures Index, and to date based on actual VXX ETF data.

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8 Responses to “VXX’s Brief Moment in the Sun”

    • 2 MarketSci

      Thank you sir – means a lot coming from one of trading favs. michael

  1. 3 Mike

    I haven’t given this much thought, at all, but would a simple dollar cost average into a short vxx position be a fairly simple and successful strategy.

    • 4 gmacd

      It’s pretty tough to short VXX. Best I managed in the fall of 2011 was buying puts on it.

    • 5 MarketSci

      Hello Mike – in addition to the issue with shorting VXX that gmacd mentions above, I would strongly discourage anyone from blindly holding a short VXX (or long XIV) position. Things can get out of hand very quickly as shown in the charts above.

      Even using DCA only when VIX futures are contangoed would be a bad idea I think. Just when DCA is of the most benefit (shorting additional shares as VXX rises), VIX futures would be moving towards backwardation and a flip back to a long VXX bias.

      Just some thoughts off the top of my head. michael

  2. 6 Chris

    Great article, Mike. I’ve recently been building a strategy that is more or less based off of the data presented in this post. I’m hypothesizing that the most effective means of profiting from volatility instruments is to always own OTM puts on VXX; this allows me to allocate a small amount of my portfolio into a highly leveraged bet that contango in the VIX futures will continue to cause VXX to depreciate. The puts also provide a hedge to any shares of VXX that I may buy to hedge my portfolio. Seems to me like such a strategy provides the best risk/reward profile, given the tendency of VXX and XIV to spike up, and down, respectively. I’m not yet however 100% convinced that one wouldn’t be better off simply buying deep OTM VXX calls. Would be curious to hear your thoughts.

    • 7 MarketSci

      Hello Chris – I try not to comment on things outside of my wheelhouse, and VIX options strategies are definitely outside of my wheelhouse. I would highly recommend any of the four blogs from my blogroll that are focused on VIX-related matters. michael


  1. 1 Thursday links: all trades end - Abnormal Returns | Abnormal Returns

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