How to go long on the VIX index

Monday, April 22nd, 2013 | Vance Harwood

Unlike the S&P 500 or Dow Jones Industrial Index there’s no way to directly invest in the CBOE’s VIX® index.  Some really smart people have tried to figure out a way, but there’s just no way to do it directly with something like a VIX index fund.  Instead, you have to invest in a security that attempts to track VIX.  None of them do a great job.  The rest of this post discusses going long on volatility, if you think volatility is going to go down see Going Short on the VIX.

For the average investor there are five ways to go long on VIX:

  1. Buy a leveraged exchange traded product (ETP) that tends to track the daily percentage moves of the VIX index.  At the moment the best of these from a short term tracking standpoint is ProShares’  UXVY and Citigroup’s CVOL.
  2. Buy Barclays’ VXX (short term) or VXZ (medium term) Exchange Traded Note (ETN) or one of their competitors that have jumped into this market.   See volatility tickers for a full list of volatility ETN/ETFs. For more on VXX see How Does VXX Work?
  3. Buy VXX or VXZ call options  ( ProShares VIXY and VIXM have options also)
  4. Buy UVXY options (2X leveraged version of the short term rolling futures index used by VXX)
  5. Buy VIX call options / short VIX put options


Aggressive

The first two choices are not for the faint of heart.  VIX’s moves are often extreme, so if you bet wrong you can lose money in a big hurry (think 15% or more in a 24 hour period), of course there is the equivalent upside if you get it right.  In my opinion these are tools for day traders that stay stuck to their screens and have have an excellent sense for market direction.   Unless the market is in a sustained high fear mode (e.g., Aug 2011 through Oct 2011) these funds will often erode dramatically over a multi-day period.   But if you are looking for the best ETN/ETF to track the VIX short term moves this is as good as it gets.

Unlike CVOL and TVIX, ProShares’ UXVY, is an Exchange Traded Fund (ETF), not the more typical ETN.  The good news is that the financial backing of an ETF, unlike an ETN is not dependent on the credit worthiness of the  provider because they are guaranteed to be backed by the appropriate futures/swaps.  The bad news is that those futures change the tax status of the fund to be a section 1256 fund—which requires filing a K1 form with your tax returns.  Typically this is not a big deal, but requires a little extra work.

While these funds do a respectable job of tracking the VIX on a daily basis they will not track it one to one.  These funds are constructed using VIX volatility futures that aren’t constrained to follow the VIX—sometimes they are lower than the VIX, sometimes higher.   The VIX index tends to drop on Fridays and rise on Mondays due to holiday effects in the SPX options underlying the VIX—the VIX futures don’t track these moves and hence the ETPs don’t track them either.


Mainstream

The second choice, buying non-leveraged volatility ETNs like VXX,  is not as twitchy, but be aware that the VXX will definitely lag the VIX index (think molasses), and it is also not suitable as a long term holding because the VIX futures that the fund tracks are usually decreasing in value over time.  This drag, called roll loss occurs when the futures are in contango.  It usually extracts 5% to 10% a month out of VXX’s price.  Proshares has an ETF version,VIXY, that tracks the same index as VXX—if you’d rather use an ETF for playing the VIX this way.

Some VXX closing values compared to the VIX index:

  • Its first day of trading, 30-Jan-09, VXX closed at a reverse split adjusted  1673.28, the VIX index closed at 44.95
  • December 2009 VXX had dropped to 608, a  63% decline, compared to the 50% drop in the VIX index value to 22.
  • 8-September-2010, VXX closed at 308, VIX at 23.25.
  • 12-January-2011, VXX closed at 133 v.s. a VIX value of 16.24.
  • 9-March-2012, VXX closed at 88.96, VIX at 17.11
  • 6-February-2013 VXX closed at 23.55, VIX at 13.41

VXX since inception vs VIX index



This is a substantial tracking error.  Given its dismal track record it is surprising that VXX usually trades over 50 million shares a day.   I think the allure comes from its reliable negative correlation with the equity markets (-3x).  If SPY has a significantly down day, you can be pretty confident VXX will have a good day—unlike some investments like gold.


Options

On June 1st 2010 options on VXX were introduced and became almost immediately successful.   I think retail investors flocked to them because they lacked most of the VIX option weirdities—such as European exercise, different expiration dates, VRO based settlement values, and greeks that are generally wrong.   VXX options have VXX as the underlying, which avoids the perpetual confusion associated with VIX options where volatility futures are the actual underlying not the VIX index.  VXX weekly options are also available.

UVXY options are relatively new, and quite expensive due to the volatility of the ETF, but if want to increase your leverage, or reduce your capital exposure they are a possibility.

The fifth option, buying VIX options, is no more difficult than buying equity options.  Unfortunately they too lag the VIX index because they are also tied to VIX futures, not the VIX index.  In addition to their sluggish performance, they have these other issues:
  • The bid / ask spreads are huge!  Never pay what is offered, use limit orders and split the bid/ask prices (e.g., if the spread is 3.40/3.80 and you want to buy, offer 3.60 or 3.70 with a limit order.)  More on trading VIX options here.
  • The VIX options are European exercise, unlike most equity options—practically this means the VIX options will predictably match (approximately) the VIX index, only once a month—the moment they expire.
  • The posted greeks (delta, gamma, etc.,) are almost always wrong.  See more here.
  • Like all options, their premium value erodes with time, especially as you approach expiration.

If you want to go long on the VIX index you are probably hoping to speculate on its big swings, or you are trying to hedge your portfolio against big, sharp declines.    If you want to speculate, be prepared to move in a  hurry—the VIX drops quickly once the market angst subsides.   Most of the action is over in a few days.  If you want to hedge I’d avoid these securities and look at  long term out of the money puts.  Being long volatility is expensive if you are trying to get enough leverage to protect a significant portfolio.

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Monday, April 22nd, 2013 | Vance Harwood
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  • Charlie Lefaux

    I would say the best option if you want to go long S&P volatility is a near-term delta-neutral straddle as opposed to VXX tracking errors and/or going long VIX futures options.

  • http://vixandmore.blogspot.com/ Bill Luby

    I'm delighted to see someone else who is interested in the VIX and volatility — and has some excellent content on the subject.

    I am with Charlie in that the best way for a retail investor to assemble a pure play on S&P volatility is with a straddle on the SPX or SPY. Here an investor also has the benefit of a favorable bid/ask spread and liquidity. The next best choice is probably VIX futures, from which, as you point out VXX and VIX options (for all practical purposes) are derived.

    As an aside, you may want to check your data source on VXX to make sure you have data going back to the 1/30/09 launch.

    Cheers and welcome to the blogosphere,

    -Bill

  • paul

    what does the stock price differential between VXX and VXZ tell you about the term structure of vol? Early 2009 both ETNs were priced above 100 and now a big difference. Has vol curve really steepened that much? Would you view those as good vehicles for playing a flattening, or steepening, of vol curve?

    thanks

  • vance3h

    Hi Bill,
    Thanks for the correction on the beginnings of the VXX/VXZ ETNs. I have corrected the post to reflect the January 2009 launch.

    – Vance

  • vance3h

    Hi Paul,
    The vol curve is not something that I follow directly. Bill at http://vixandmore.blogspot.com/ is a better resource.

    As a longer term investment VXX has shown that it doesn't track the VIX index short term volatility metric particularly well. Their methodology requires them to roll over from current month to next month volatility futures on a daily basis–which hurts them if the next month futures are valued higher than the present month (“in contango” in futures terminology)–which seems to the be the typical case. VXZ is not very popular (only $30M in assets compared to $704M for VXX), so I suspect the bid/ask spreads are wide.

  • http://vixandmore.blogspot.com/ Bill Luby

    Hi Vance,

    I didn't realized this was your new blog. Anyway I like the new look and feel and have replaced the old blog with the new one on my blogroll.

    Hoping seven or eight figure investing is just around the corner,

    -Bill

  • vance3h

    Hi Bill,
    Thanks for the feedback. I’m hoping to learn more about SEO, and my son, who is a web designer informed me that WordPress was the way to go. It was a significant learning curve, I hope it’s worth it. Thanks for the bogroll mention, I really appreciate it.

    – Vance

  • sam

    Is trading the Vix like trading a stock or does it expire like an option

  • vance3h

    Hi Sam, I assume your question relates to the VXX, because you can’t directly trade the VIX itself. The VXX doesn’t expire, so in that sense it is like a stock. However the VXX will never behave like a good growth stock with the prospect of growth every year. Instead it is fated to bounce between two levels, one established by elevated volatility, and the other established by the moderate movements of a quiet market. In fact, its long haul prospects are even worse than that–because its sponsors must continually roll over the futures contracts it’s based on there is a structural erosion factor built into the VXX. Over the long run (multiple months) the VXX will always go down. For that reason I don’t consider the VXX a buy-and-hold candidate. You should only buy it when you think the market it going to fall sometime in the near future.

  • Anonymous

    You can’t trade the VIX directly. You can trade VIX options, which are based on VIX futures, or VXX / VXZ and their options–which are based on a two month rolling mix of VIX futures. See my “popular posts” section on the right side of my blog for more info.

  • Cliptose

    the best way to hedge a long portfolio is holding etfs that pay good dividends and reinvesting when it hits the bargain basement. When you have almost 13 million shares of SPY we are going to be PAID no matter what the market does.

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  • Nickycee1

    I strongly disagree on CVOL. Yes, it is thinly traded but spikes heavily at times of uncertainty. It may trade 25,000 in a day then trade 200,000 a week later. I like it much more than VXX which is not as volitile. I think VIX ix going to 50-60 in early 2013 and CVOL will spike more than any other VIX trade and at a much higher % than VXX.

  • vance3h

    Hi, I hadn’t looked at CVOL in a while. I agree the volumes are respectable and the spreads aren’t too bad. The contango losses are bad, but much better than TVIX / UVXY. I’ve changed my post to put CVOL equivalent to UVXY. However medium to Long term I think CVOL will go away. Citigroup should have reverse split it by now if they plan to go with it long term. With only $6 million in assets they will probably let it fade away/ delist. It will probably take a year for that to play out.

    – Vance

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  • http://twitter.com/Vedast Vedast Sanxis

    Hello Vance. You say that contango extracts 5-10% from VXX. Should we expect that decay to exist in the long term? I’m considering buying SVXY shares and just hold them “forever” to profit from VIX futures contango.

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    Hi Vedast, The big problem is volatility spikes. You could easily see 50%+ of the value of your position vanish in a few days. Yes, eventually it will probably recover, but it might take years. Not many people can stomach that big of a drawdown without pulling out. Using a ratio like VIX/VXV to manage your position would probably help some, e.g., my backtest for XIV, stay in if the ratio is less than 0.917 limited the drawdown to “only” 25%.

    – Vance

  • http://twitter.com/Vedast Vedast Sanxis

    Hello Vance. Thank you for your reply. I realize that volatility can be really high, and I’d try to compensate that with other parts of my portfolio. Do you think that the monthly expected returns in the long run are as high as 5%-10% per month (minus VXX and SVXY annual fees)? I wouldn’t care dealing with big drawdowns if I have that kind of expected returns :)

  • http://www.sixfigureinvesting.com/blog Vance Harwood

    HI Vedast, Using 28Dec11 through 28Dec12 the VIX was only down 7% for the year, but XIV’s monthly CAGR was +7.5%. This was a quiet period, but it shows what a contango powered period is capable of. By the way, I expect 2013 to be a more volatile year than 2012–maybe something like 2007.

    – Vance


The Volatility Landscape 2-May-2013

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