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Finding The Right Volatility ETF

Summary Volatility products can provide market leading returns. Proper education and knowledge of the VIX futures market is needed to be highly successful. Risk factors should be accounted for when creating and implementing your strategy. Welcome to the Seeking Alpha ETF Guide. This article will focus on how a VIX ETF could play an active role in your portfolio. When looking for a VIX ETF you have several different options between short-term and mid-term futures products. This article will cover only the most active funds. For more options visit the Seeking Alpha ETF Hub for a list of all volatility funds. Both types of products (short and mid-term) focus on the VIX Futures which trade independent of the market and the popular and well publicized VIX Index. Short-Term There are two types of short-term volatility products. To determine which type of product is for you, you first need to determine whether you are betting on an increase or decrease in volatility. Long volatility products, such as iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ) and ProShares Ultra VIX Short-Term Futures (NYSEARCA: UVXY ) which offers two times the leverage, benefit from increasing volatility. During periods of low or decreasing volatility, inverse products such as VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) and ProShares Short VIX Short-Term Futures (NYSEARCA: SVXY ), produce better results. All short-term VIX products focus on the front and second month’s contract in the VIX Futures. Mid-Term You also have long and inverse options available in mid-term futures products. For rising mid-term futures you have VelocityShares Daily Inverse VIX MT ETN (NASDAQ: ZIV ) and for decreasing mid-term futures there is VelocityShares Daily Inverse VIX MT ETN . All mid-term VIX products focus on the seventh through fourth month’s contracts in the VIX futures. Mid-term futures products are not as popular as the short-term products. Education Investors looking to use VIX products in their portfolios should have a very high level of education into the inner workings of the VIX Futures market. Seeking Alpha is a great resource for many articles that focus on the how and why rather than the right now. I have written many articles that are specifically geared towards investor education and are meant to serve as training tools for years to come. Since the vast majority of these products have been around less than a decade, back testing is often used to demonstrate the effectiveness of different strategies. Investors should also note there are distinct differences between short-term and mid-term volatility products. A personal pet peeve for me is when I see comments such as “this thing is rigged.” That is a good example of someone who hasn’t educated themselves on volatility and is now mad about their poor decision. Many misconceptions exist in regards to VIX Futures products. A thorough understanding of how these products are structured can prevent expensive mistakes. Trades based on hopes and dreams or borrowed money are a recipe for disaster. A proper education is the only way to prevent failure when trading volatility. Contango/Backwardation A key indicator when determining longer-term directions of volatility products are contango and backwardation. Contango will benefit inverse volatility products, like XIV, while backwardation will benefit long volatility products, such as VXX. For more information on this key metric I recommend this short video . Trading Objectives Long volatility products – Many investors use long volatility products as insurance for their primary portfolio. It is difficult to time spikes in the VIX and these products lose value over time. They are not meant to be buy and hold investments. From historical data, the longest these products have gone without losing value is less than one year. Inverse volatility products – During flat and rising markets, these products can often beat the major benchmark indices. Although I don’t advocate a long-term buy and hold strategy with any volatility products, short-term inverse funds have provided the best returns when held for periods of 2-6 months. Risks This would be the most important section of this article. I have spent countless hours promoting the education and risk factors of investing in various VIX funds. Although these products can provide returns several times greater than the market, they also come with many risks that are hidden to novice investors. I have seen many beginners with high hopes of getting rich quick. They may win the first or second hand but eventually lose all or a very significant amount of their capital by not properly assessing risks before making trades. If you do not fully understand how these products work or do not have a thorough idea of the risks of investing in volatility, my recommendation would be to avoid them while you become more comfortable and complete additional research. Practice accounts and small trades are a great way to build real knowledge on the effectiveness of your strategy. Rising markets make inverse products seem like the perfect investments. However, these products can easily lose 50-80% of their value during periods of economic turmoil. Black swan events are rare but would significantly effect volatility products. Historical examples of these events would include acts of war, terrorism, and other unforeseen events that would have profound impacts on the market. Returns VIX funds have provided some of the best returns over short to medium time frames. Take a look below at some of the best results for inverse and long volatility products: Chart created by Nathan Buehler using backtesting data from The Intelligent Investor Blog . Conclusion The best advice I can give if you are thinking about trading volatility is to learn as much as you can about how these products operate. Test your strategies, document results, confirm successes, and evaluate failures. You should feel very comfortable with using these products before making your first large trade. Seeking Alpha is a great resource to use. By interacting with contributors and other users, you can create your own virtual professional learning community. I hope you have found this introduction to volatility funds useful. Now it is time to start researching and comparing individual funds. Thank you for using the SeekingAlpha ETF Guide!

Time To Buy ZIV Again

I last recommend ZIV at 39 in October. That trade worked out nicely. ZIV is back at 39 and is again an attractive buy here. I last discussed the VelocityShares Daily Inverse VIX Medium-Term Futures ETF (NASDAQ: ZIV ) in mid-October, calling it a buy to take advantage of excessive market negativity surrounding the potential for an Ebola outbreak in the United States along with uncertainty in the Middle East. ZIV proceeded to rise from 39 to 46 in a straight-line, offering near 20% gains for nimble traders. It’s time to go back to the well as ZIV is again offering a reasonable entry-point. New concerns have shaken the stock market, with pressures from plunging oil prices and earnings misses causing new waves of volatility. Again, like in October, the near-term part of the VIX futures curve finds itself in contango, meaning that it is a bit troublesome to short the iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ) directly. If the VIX futures curve stays where it is currently, VXX will rise gradually just from enjoying the backwardation the market is in. As you can see in the graphic shown later in this article, VXX benefits roughly 2% a month if the futures curve stays as is, which isn’t a huge headwind to the short trade, but it is a deterrent for sure. When you combine that with the cost of borrowing VXX to short, in addition to considering that short VXX has much more risk than long ZIV (since VXX tends to rally far more quickly than ZIV drops), again I’d be preferential to a long ZIV position than a short VXX position here to profit from the excessive volatility priced into the market at the moment. ZIV is an attractive long as the broader market continues to enjoy support around 1990 on the S&P 500 index (NYSEARCA: SPY ). While the market has suffered a few bumps over the past month, economic conditions remain generally favorable and the Fed doesn’t seem inclined to raise interest rates particularly quickly. Fears over Europe have plagued the market since at least 2011 and are unlikely to hold any more merit this time around. Oil prices are a potential hazard, as the energy sector has suffered severe losses, however the benefits of cheaper energy provide sufficient positive feedback to other sectors that the overall impact on the market appears to be contained. Since I last discussed ZIV, the instrument enjoyed a quick 20% rally and then has gradually slid back down to where it traded previously. With this past week’s volatility, ZIV took a nice dive, and now finds itself back at 39, where we dealt with it previously. It’s firmly back in the buy zone, and conditions are equally favorable in comparison to our last entry. I’ve reproduced the chart from our October ZIV buy at 39, with the futures curve today, ZIV also at 39. There’s one positive and one negative, and on the whole it works out to be a wash in my view. (Charts from Vixcentral.com) VIX futures October 17th, 2014: (click to enlarge) VIX futures now (as of 1pm ET Friday): (click to enlarge) On the one hand, ZIV was gaining 1% a month purely from contango. It was buying January futures at 19.36 and selling at 19.93, which produces a 3% gain on each roll. Divide by 3 (since it holds the contracts for 3 months), and you get a percent a month, or more than a 12% compounded annual return if volatility is flat and it just reaps the contango harvest. Now, however, the contango yield has fallen to roughly 0.6% a month, or a bit over 7% annualized, which is a good tailwind to the trade, but not as strong as previously. VIX futures in comparison, October 18th, 2014 versus now: (click to enlarge) However, note that the whole term structure has moved upward. Before ZIV was buying futures at 19.36 and selling at 19.93, now it is buying at 20.05 and selling at 20.45. Thus, ZIV, which is perpetually shorting VIX futures contracts, now has a notably better cost basis for its short positions. This is the beauty of ZIV as a longer-term investment or long-biased trading vehicle: ZIV’s net asset value consistently rises even as the market bounces around; returning to and then deviating again from the mean. What does this mean practically? ZIV is again at 39, where it was in October. However, ZIV’s cost basis for its short positions has now improved by 5%. Should the VIX futures head back to where they were in October, in the low-19s, ZIV would now make a 5% capital gain, moving higher to 41 per share. This before any benefits from contango. While ZIV is priced the same as during the October dip, the VIX curve is higher than before, now offering more potential upside for ZIV on a market normalization to calmer conditions. If VIX settles down in similar fashion to how it did in October, ZIV would reach 48 on this next upswing, taking it almost 25% higher and back to near 52-week highs. Taking a longer-term view of ZIV’s chart, ZIV gradually rises something along the order of 1% a month (what it earns on average from contango) while it swings upward and downward around the trend-line as the market fluctuates. ZIV’s next sustained push higher should take it above 50, as it is overdue for a new high when the market gets over its near-term crisis of confidence. The risk to the trade would be if the market has topped. At some point the bull market will end, and ZIV will no longer be an easy buy on dips. At that point we’ll have to watch the VIX structure closely to see if ZIV stays in contango or not. Should it go into backwardation, like VXX, we’d have to reconsider the viability of the trade. As it is, I don’t think the bull market has ended yet. And alternatively, short VXX will work out better than long ZIV if you are convinced that the market immediately calms down from here. In October, the panic subsided quickly, and shorting VXX did produce a better percentage gain than ZIV. This could happen again if the S&P 500 quickly moves back to its highs. As I’m not convinced this is going to happen, I’d rather take the much more conservative ZIV trade, which offers high probability of 20% near-term upside with limited downside. Disclosure: The author is long ZIV. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.