Tag Archives: nysearcavxx

Sell UVXY: It’s Still A Busted ETF Heading Lower

UVXY is a widow-maker of an ETF, down more than 99.9% over the past five years. A recent trebling in its share price is irrelevant to longer-term investors. UVXY is still a terrible product, sell it or short it. It’s going to drop further. Volatility ETFs are one of the worst inventions to hit retail investors in the past decade. These products that are literally designed to go to zero if you read the fine print in the prospectus. And yet thousands of small-time investors and speculators get sucked into them, thinking this is a good way to bet on, or even prudently hedge against volatile markets. The iPath S&P 500 VIX Short-Term Futures ETF (NYSEARCA: VXX ) is still the gold standard for the space. And it’s a very lousy product. Short it or avoid it. However, with the dark magic that is a leveraged fund, you can take the inherent terribleness of VXX and cube it. Enter the ProShares Ultra Vix Short-Term Futures (NYSEARCA: UVXY ). The Velocity Shares Daily VIX 2x (NASDAQ: TVIX ) is basically the same functional product as UVXY in a slightly different wrapper and with less trading volume, but the same analysis applies. VXX, UVXY, TVIX and other such long volatility instruments are designed to benefit when the VIX rises. However, since VIX – somewhat inaccurately known as the “fear gauge” — is a mathematical construct rather than an actual investable instrument, no ETF tracks VIX properly. What you’re investing in when you buy VXX or UVXY isn’t the VIX you see scrolling across the CNBC ticker but rather a blended combination of futures contracts (derivatives) that aim to predict where VIX will be at a later date. There’s usually a large disconnect because VIX today and VIX in the future, leading to the returns on VXX and UVXY not coming close to what you’d expect just looking at spot VIX changes on the day. The general case against VXX and UVXY is rather simple. Volatility in the future is generally projected to be higher than volatility today. Since traders fear unknown future events more than the present knowable situation in most cases, traders will pay up more for protection farther into the future. Traders are usually more fearful of a crash farther along the horizon than in the short-term. Since VXX, UVXY and others own a mix of current month VIX futures and next month VIX futures, they tend to lose value when they have to rollover contracts. Say spot VIX as quoted on CNBC is 14, VIX futures for September are 16, and VIX for October is 18. Every day, VXX and UVXY have to sell some of their September contracts at 16 and buy Octobers at 18. They lose more than 10% of their net asset value (NAV) every month rolling over. Once October comes, October futures will be down to 16, Novembers at 18, and they’ll lose another 10% rolling again. VXX tends to lose about 70% of its value every year, and it’s largely driven by this effect. The long term impact of this effect, named contango, is most difficult. It’s why these funds always go down over the longer term, and why they make for poor investments. VXX is down from a peak of 7,000 (split-adjusted various times) in 2009 to 29 today. A drop of 99.6% since inception. UVXY’s done even worse, given the 2x leverage, falling from almost 500,000/share (yes, you read that right) to 64 just since 2011! (click to enlarge) Ouch! These are very-poor performing investments that most folks should steer clear of. However, now that the market is dropped and UVXY has tripled off the lows, everyone’s all excited about volatility products again. Now the talk of the town is that volatility is in “backwardation” meaning the usual value-destroying albatross that hits these investments is no longer in play. Backwardation, explained simply, is that now this month’s futures are worth more than next. If you can sell Septembers at 18 and buy Octobers at 16, your (NAV) rises 10% a month. If that state is maintained for awhile, particularly with UVXY’s leverage, you get some fat upside. And yes, that’s all true. But no, it doesn’t generally play out like that. Look at the long-term log chart of UVXY posted above. There were two periods of relatively long-lasting backwardation, during both the 2011 and 2012 market sell-offs. And UVXY and TVIX did indeed benefit from rising volatility and backwardation… however, the increases were very small compared to the larger downward trend. These instruments are so poorly constructed that brief periods of backwardation don’t move the needle. Backwardation almost never persists for a lengthy period of time because the market is almost always more fearful for the future than the present. Unless you’re actively seeing markets go through the floorboards right now, like during the recent Monday’s flash crash festivities, volatility expectations are almost always higher at a later date than what you see at present. While UVXY got to 90 during the current panic, it sold back off to 60 in just two days on a rather modest market recovery. And Tuesday, it dumped 19% again in a single day. Any instrument where you lose 33% of your money in two days or 19% overnight during a fairly routine market recovery is best avoided by most market participants. When you’re long UVXY, you are playing with fire. September VIX futures are currently at 26. Around 15 has been normal during this bull market. So just a reversion to normal wipes out more than a third of VXX’s value, and UVXY will suffer losses greater than that due to the leverage. The lottery ticket type upside in a crash scenario just isn’t worth the near certainty of an 50-75% loss in UVXY in coming weeks as the market and volatility stabilize. Even if you manage to time a sell-off correctly, you’re almost undoubtedly better off just buying puts on the market, through an ETF such as SPY. UVXY may go up 6x-8x if you hit a sell-off just right. Getting that, or a whole lot more, from SPY puts is no more difficult. In a perverse sort of way, it’s nice that these ETFs’ lives have dragged on as long as they have, as they are among the best short sales in the market. It will be a sad day when these sources of easy alpha are taken away from the short-selling arsenal. Disclosure: I am/we are short UVXY, VXX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

How To Invest As Fear Is Thrown Into The Market

Summary As fear increases in the market, volatility has rapidly risen in one of the shortest timeframes on record. Traders betting on a normalization of expectations should position for an eventual decline in volatility. Investing alongside the impact of contango results in the best returns. Investments never consistently trade in a single direction forever. Over the past week, the crash of major stock indices has been a stark reminder that surprises to investors can happen very quickly and that fear itself can often prove to be a powerful force to be reckoned with. Yet potential opportunities exist in every situation. One such trade to now consider is the eventual suppression of uncertainty as the stock market once again normalizes and regains its composure. Over the last few days, volatility has very rapidly been increasing as a result of this uncertainty. This can be seen in the graph of the Volatility S&P 500 Index (VIX) found below as compared against the S&P 500 represented by the SPDR S&P 500 Trust ETF ( SPY ) . The VIX is quoted in percentage points and roughly equates to the expected movement in the S&P 500 index over the subsequent 30-day period when annualized. The index is a largely constructed by utilizing the implied volatilities of a wide range of S&P 500 index options. In general, the VIX represents the expected swing of the market in either direction as an expressed percentage over a given period of time. Since trading at a low of $13 on Monday, August 17, the Volatility S&P 500 Index soared to a closing price of $28 on August 21. This is greater than a 100% rise over the course of days, and therefore represents one of the most sudden movements recorded in the index’s history. It also reflects the high degree of uncertainty in the market as investors scrambled to buy options in order to gain protection for their investments. Yet as it often tends to be the case, fear and uncertainty naturally subside over a given course of time. Historically, this too can often unfold in a very rapid manner. As noted in the graph below, the VIX frequently spikes only to rapidly return back to a more sustained level in the mid-teen price range. Reasonably, this allows for a trader to predict and to invest into the normalization of market uncertainty by positioning for the eventual decline in the VIX. While investors can directly invest into the VIX through the utilization of call and put options, those unfamiliar with the use of these trading tools can still capitalize upon this predictable trend. One such investment method is to consider a short position in a related fund that is correlated to the VIX. For example, the iPath S&P 500 VIX Short-Term Futures ETN ( VXX ) is an exchange traded note that offers exposure to the daily rolling long position in the first and second month VIX futures contract. Yet as a consequence of contango, the VXX is almost inherently designed to decline in value. Contango occurs due to the perishable value of the premium attached to futures prices set before the expected delivery date. As a consequence of contango and the reliable trading action of the VIX itself, the long-term trend of the VXX is made abundantly clear in the graph shown below. Over the long-term, contango and the lack of a consistently fearful market typically dictate the downward trend of the investment. As seen in the graph below, such a trend has been well defined for many years. (click to enlarge) However, not everyone is capable of entering into a short position. There is also an inherent danger as the potential losses of a trend that backlashes against expectations are theoretically limitless. Therefore, investors could alternatively go long a VIX inverse investment such as the VelocityShares Daily Inverse VIX Short-Term ETN ( XIV ) in order to capture a similar trend. This investment seeks the inverse performance of the S&P 500 VIX Short-Term Futures Index. For those wanting to limit the volatile nature of the this long position, one can also consider the VelocityShares Daily Inverse VIX Medium-Term ETN ( ZIV ) . This investment seeks the inverse performance of the S&P 500 VIX Mid-Term Futures index. The difference between these two futures indices is that the short-term index utilizes the prices of the next two near-term futures contracts whereas the mid-term index utilizes the prices of the fourth, fifth, sixth, and seventh month future contracts. As a result of this, the mid-term index faces significantly less volatility and a reduced impact from contango. The resulting trends of each of these investments can be found in the comparison graph below. While both XIV and ZIV have historically trended higher, it is clear that traders seeking higher returns are more prone to invest into XIV following a deterioration of the upward trend, which occurs when increased fear returns to the market. Final Thoughts It is important to remember no one is capable of predicting the future with perfect accuracy. As such, both traders and investors should often consider utilizing multiple entry points in order to average down into a comfortable position. Just because fear and volatility have risen to a very high point in a limited amount of time, there is no reason to believe that it will not be able to continue to rise in the days and potential weeks to follow. Nevertheless, for the patient investor capable of identifying opportunity when it passes by, the potential return from a predictable trend found in volatility can often be quite rewarding. After all, the odds of a market that continues to consistently become ever more fearful is rather slim statistically. Disclosure: I am/we are long XIV, ZIV. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Time To Short Volatility Again

VXX has spiked in recent days on China fears. But I think the conditions for a short of VXX have been met. Contango has disappeared and that has been a reliable signal in the past. I’ve written several times in 2015 about volatility and specifically, shorting the popular short term VIX ETF proxy VXX (NYSEARCA: VXX ) as I’ve taken the occasion of various spikes to bet on normalization. Last time I wrote about such a trade it was during the July meltdown stemming from the now-distant Greek crisis and that trade returned very nice profits, as you can see below. Well, here we are again as the VXX is spiking once more on China’s woes or any other global event investors can think of. (click to enlarge) My basic premise for entering a short VXX trade is pretty simple; wait for a spike in VXX, assess the reasonableness for a sustained higher VIX level and if there is none, short VXX. It really isn’t more complicated than that. VXX is a great vehicle to short because of its famous contango. It costs money (most of the time) to hold VXX due to contango so the opposite of that is that shorting it has a natural tailwind. This is the second cue for me in knowing when to short VXX and when to wait for a better entry point. But first, let’s assess why the VIX is spiking. Seems to me market participants are up in arms about China’s most recent meltdown and while that’s fine, just like the Greek crisis, I believe fears are overblown here. S&P earnings are also suffering somewhat and the market is losing leadership in a lot of ways so for me, that is a much bigger problem than China’s latest bubble popping. I know there are many people that would disagree with me but I just don’t get it on China. Therefore, the first condition of my short signal has been met; the reason for the spike seems improper and in particular, the magnitude with which VXX has spiked. We’re up double digits in two days on the VXX and for what? The second signal I mentioned is when VXX is no longer in contango, that has historically been a great time to short it. I like to use VIX Central to chart the VIX curve and determine the level of contango because it makes it easy for even novice VIX watchers to understand what is happening. I’ve pulled two charts from VIX Central below to illustrate my point. This first chart is a straight look at the VIX curve. Since the VXX deals with short term VIX contracts, we’re really only interested in the first two months. As you can see, as of yesterday’s close September and October were at exactly the same level and even November and December were only pennies higher than the front month. That means contango has disappeared and when that has happened in the past, it was a great time to short VXX. This chart shows the level of contango between the first and second month VIX contracts for the past several years and as you can see, flat contango and backwardation are rare. But when either of those conditions are met, we are usually due for a sell-off in front month VIX. That means that when we reach the level of contango we are at right now (zero, the red line on the chart), while we may move a little higher, history suggests the odds are heavily in favor of shorting VXX right now. So here’s the setup; the SPY just hit a six month low yesterday and after the beating the market has taken in the last couple of days, I think today will be a flat to lower day. That means VXX will probably be higher on Friday and that is where I will make my short. I will use the recent spike in VXX to short it as I think we are nearing the top of this particular spike. Now, I’ll make my standard VXX trade disclaimer because I don’t want anyone to get the wrong impression. Trading VXX is very risky and extremely volatile and thus, you must understand that the potential reward is high but so is potential risk. Please understand what you’re doing before taking a long or short position in VXX because it moves around a lot and can make or lose you a lot of money in a very short amount of time. I’ve been on both sides of VXX trades and I can tell you it can wipe out a lot of value quickly. The odds are in favor of a VXX short right now and I think today is the perfect opportunity to take a short position in VXX given that the spike in volatility seems overblown. I also think the market is near a base and will rally from here so that is also a favorable setup for shorting VXX. This position is not without risk but given the setup we have now, VXX shorts are heavily favored here. Good luck out there. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in VXX over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.