Tag Archives: vxx

Have The Volatilty ETFs Turned A Corner?

Summary Trying to play US equity volatility has been really tough for retail investors in recent years. Over the past four years VIXY and VXX are both down over 58%. Volatility has increased in other areas of the capital markets which is a positive sign long-volatility ETFs. Trying to play pure volatility as a retail investor is tough. Not only can you not invest directly in the widely watched VIX, but ETFs that attempt to track the VIX end up with a substantial tracking error. This occurs because volatility ETFs such as the ProShares Vix Short-Term Futures ETF (NYSEARCA: VIXY ) track an index made up of VIX futures. When future prices are in contango (as is usually the case for VIX futures), this creates a negative roll yield that eats away at the ETFs price. Over the past four years, VIXY is down 58.6%. The iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ), which tracks the same index as VIXY, is down 58.5%. Out of 1081 ETFs that have at least four years of trading history, VIXY and VXX have had the 6th and 7th worst performance over the past four years, respectively. With that nasty backdrop the silver lining is that for the first time in quite a while there are indications that pure play volatility investments could begin to pay off. In general, greater volatility in one segment of the capital markets tends to lead to overall greater levels of volatility in all segments of the capital markets. For example. a month ago junk bond spreads widened out to multi-year highs and look to be on the verge of making new highs very soon. As the chart below shows, greater volatility in the bond market tends to coincide with greater volatility in the equity markets. (click to enlarge) (click to enlarge) Volatility among major currency pairs has also been substantially higher in 2015 than the majority of the last several years. FX volatility has been pointing to increased equity volatility for quite some time. Equity volatility in other parts of the world is on the rise. The VDAX, which is similar to the VIX but for the German equity market, broke out to a multi-year high a month ago. Macro risks around the world are on the rise. The Citi Macro Risk Index “measures risk aversion in global financial markets”. It tracks various CDS spreads, credit spreads, swap spreads and implied volatility across FX, equity and swap rates. As this index rises, the perceived amount of risk in the global financial system increases. After falling for most of the year, this index is sharply higher over the past six weeks. Finally, on a relative point and figure basis, both the VIXY and VXX have recently broken though a firm resistance line that has been in place for four years and they both seem to have been in a basing formation for about the past 18 months. If this base can hold than there is a tremendous amount of potential upside for VIXY and VXX. VXX relative point and figure chart VIXY relative point and figure chart The original posting of this article can be found here . All data was created by the author and sourced from Gavekal Capital, MSCI and FactSet.

I Was Wrong About Shorting Volatility

I posited at the beginning of this correction that shorting volatility looked very enticing at current levels. That has turned out to be a terrible call as my belief that there would be a quick rebound in the equity markets was disproved. I’ll provide my outlook for the markets and shorting volatility going forward from here. Ever since the current market rout started, I’ve been salivating at the chance to get short volatility via the short term volatility ETF VXX (NYSEARCA: VXX ). This is a strategy I’ve used repeatedly over the past year or so to take advantage of buying the dip on a leveraged basis and it has worked very well. Unfortunately for me (and many others) this dip turned into a correction. My last post on the subject seems like ages ago at this point but if you’d like to see my rationale at the time, please take a look. Some time has passed and the landscape for shorting volatility has become a lot more complicated so in this article, I’ll update my views on shorting volatility and see what I think is next for markets and VXX. (click to enlarge) Obviously, I was too early. That comes from my steadfast belief in “buy the dip” that has developed over the past six years of this bull market. It has worked beautifully in the past but of course, this time it did not. This is why it is important to keep volatility-related positions small and why I always issue that warning in VXX pieces. I’ll issue it again here and offer that any position in VXX is, by its nature, speculative. Please keep positions small and understand that the potential for large rewards comes with the potential for sizable risks as well; the chart above shows this better than my words can convey. Now that we’ve established my original premise for shorting volatility this time around has proven to be unequivocally incorrect, let’s take a look at what may happen in the short to intermediate time frames with respect to the market and the VXX. The fact that the VIX is still elevated above 23 this many weeks into the correction is something I never thought would happen as it was beginning back in late August. I saw the spike down as just that and nothing more but obviously, we have something larger on our hands here. (click to enlarge) The VIX is showing tremendous ability to remain elevated and given the term structure at present, it appears traders think it will continue or even go higher. Credit: VIX Central We can see the spot VIX is near 24 while the front month is just over 22. But if we look further out, there is only a small drop in what the market is predicting volatility will look like several months into the future. While this isn’t unusual during a correction, there is real money on the line here so there are some traders with serious firepower betting on a sustainably higher VIX. The second mistake I made is in assuming contango would disappear quickly, as it had during so many quick down turns in the market in the last several years. As you can see, I made a pretty high probability bet that the spike in contango would be short-lived. Obviously, that is not the case. While contango has lessened significantly, it is still present. And as the down turn in 2011 showed us, it can stay that way for a long time. Given the way the VIX is behaving so many weeks into the spike, I have to think we are in for some more suffering before things get materially better. Now, these two conditions were the very reasons I originally put my short VXX trade so I’m not going against my system that has worked time and again; what I’m saying is that this time is different and requires a different approach. I found out this time was different the hard way – by losing money – but that doesn’t mean we can’t adapt and learn. First, I think the equity markets are in for some more selling before repairs can be made to the damage that we’ve seen in the past six weeks or so. We can see here that when the market (NYSEARCA: SPY ) broke down, it broke down hard and hasn’t looked back. (click to enlarge) The spike bottom has yet to be retested and the SPY formed a rising wedge pattern in the midst of a down trend, usually a bearish formation. We can see the formation was broken in the last week or so and stocks have moved down ever since. I think this wedge pattern coming to completion and the fact that there are no catalysts to buy mean a retest of ~187 on SPY is very likely and perhaps, even a move lower than that. The bottom line is my short to intermediate term outlook on the SPY is negative until we get a retest of the spike lows and until that happens VXX’s bias is up, not down. While the basic conditions of my short VXX trade are still in place (contango, elevated VIX) the one other major condition (a healthy stock market) has disappeared. That means VXX, VIX, and contango could stay elevated for extended periods of time and that means the short volatility trade is probably going to tread water or see another move lower in the coming weeks. I moved out of my short VXX position for a sizable loss because conditions changed and my reasoning for the trade in the first place evaporated. While taking losses is very painful, it is the right thing to do when you are proven wrong by the market. I will short VXX again at some point but I need to see a few things first. I need to see the SPY retest its lows successfully. That will mean a move down from current levels and some painful selling to set up a base that currently does not exist. Until that happens, shorting VXX is very dangerous. Second, I need to see the VIX sustain selling pressure. Until the market retests its lows the VIX is likely to stay elevated. That means shorting volatility in general isn’t going to work. Lastly, I think time is the final condition. This correction has taken a psychological toll on investors and that takes time to heal. Extremely volatile action like we’ve seen causes people to bail and until calm is restored, sustained buying pressure – and lower volatility – are going to be hard to come by. The time will come to short VXX again will come but for now, I’m out of this trade. I was proven wrong by the market so I’m licking my wounds until a better opportunity presents itself.

VXX Benefiting From Backwardation, For Now

Summary VXX is benefiting from backwardation for now, we will discuss how long that might last. Historic contango and backwardation levels in relation to VIX futures. Your focus should remain on U.S. economics. First, thank you to everyone who shared or contributed to my 360 degree math classroom project . You guys are awesome! Let’s jump right in: Backwardation began on August 20th, 2015: (click to enlarge) As we discussed in the previous article , longer periods of backwardation will have positive effects on the ProShares Ultra VIX Short-term VIX Futures ETF (NYSEARCA: UVXY ) and the iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ). Popular inverse volatility products, such as the ProShares Short VIX Short-Term Futures (NYSEARCA: SVXY ) and the VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) have been hammered during this period of backwardation and market head fakes: How long will this last? I believe this is the number one question at hand currently. Additionally, I believe there are two outcomes in the short-term. The Federal Reserve moves to raise rates providing a negative jolt to the market. The Federal Reserve moves to keep raise low, providing a short-term positive jolt to the market. I would personally view a delay in rate hikes as a negative on the U.S. economy. Eventually rates will rise and Wall Street has enjoyed easy money for a long time. The Fed has many things to take into account and I believe they are backed into several corners in regards to their inflation targets. To complicate this decision we have China and all of the talk about its slowing economy. I highly recommend this read by one of my favorite authors, Jeff Miller. I’ll be the first to admit that I really don’t know that much about China or its economy. I think Jeff does a good job of putting things into perspective. I also highly recommend his weekly Weighing the Week Ahead series. Economics If you have followed me for a significant amount of time, you know my feelings towards economics and the VIX. Short-term events are often not tied to economics, while longer-term VIX events are. This current event falls under the economic category and it is waiting on confirmation of a weakening economy. Whether the economy begins to weaken or not is now the question. This article isn’t to discuss the state of the U.S. economy but rather how potential changes could affect the VIX. For the most current economic data I like to us the investing.com economic calendar . Here is what you need to know: If negative economic conditions arise, even in light of a delayed rate hike, backwardation could persist for a much longer period of time. If positive economic conditions remain, than we will see a return to contango shortly, even in spite of short-term negative response to hike in rates. Current Advice Patience is needed now. If futures revert back to contango, I plan on initiating a short position in UVXY through options or purchasing XIV. This position will be small as futures could easily revert back to backwardation. For more on the contango and backwardation strategy, along with the backtesting results of this strategy, I recommend viewing my previous article here . Look below for the long-term back tested results of VXX: Chart created by Nathan Buehler using historical data from The Intelligent Investor Blog . The point of this graph is to demonstrate that the longest periods of time VXX has gone without losing value, is around one year. This is primarily due to the effects of backwardation just as contango has a long-term positive effect on XIV. For more information on what drives VXX, I recommend viewing this article . Chart created by Nathan Buehler using historical data from The Intelligent Investor Blog. To describe the above chart, the weighted future is the front and second month added together and divided by two. The best times to purchase inverse futures products or short long volatility products have come after prolonged periods of extreme backwardation. We are not going to see that type of event here unless U.S. economics begin to turn negative or show more negative signs than what is currently being reported. For now, I would continue to monitor the situation and keep a very close watch on the FOMC meeting coming up soon, economic reports out of China (and the rest of the world), and most importantly economic data here in the U.S. As a final thought, October is historically the most volatile month for volatility. Seasonality doesn’t always pan through so it is just something to ponder. Feel free to share your thoughts and comments below. The last article had over 160 comments and I really enjoy the conversations and learning that occurs when we can come together and discuss strategies, predictions, and outcomes in a professional setting. I hope you have a great week! Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XIV 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.