VXX’s Brief Moment in the Sun
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:
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).
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:
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.
(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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