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:
- 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. VelocityShares’ TVIX is also popular, but it has a persistent tracking error of around 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?
- Buy VXX or VXZ call options ( ProShares VIXY and VIXM have options also)
- Buy UVXY options (2X leveraged version of the short term rolling futures index used by VXX)
- Buy VIX call options / short VIX put options
- Buy VXST call options / short VXST put options
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.
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
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.
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 eccentricities—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 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 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.
The sixth, and newest choice is VXST options. They are very similar to VIX options except they are based on an index that tracks 9 day expectations of volatility instead of the 30 day timeframe of VIX. The CBOE introduced futures on the VXST index in late 2013 and introduced VXST options on April 10th, 2014. Shorter timeframe expectations of volatility are inherently more volatile than longer, so the VXST index will be more volatile than VIX, however since volatility futures and options lag the indexes these products bring us closer to the holy grail of being able to invest in the VIX directly. There isn’t much history, but initial indications are that the daily percentage moves of these futures and options will behave much more like the VIX than the VIX’s futures & options. For more on trading VXST options see 13 Things You Should Know About VXST Options.
If you want to trade the VIX 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 over the longer term I’d avoid these securities and look at long term solutions like Barclays’ VQT, Powershares’ PHDG, or VelocityShares’ SPXH and TRSK. Being long volatility is very expensive if you are trying to get enough leverage to protect a significant portfolio.
- Backtest of VXX Volatility ETN From 2004 Including Yearly Fees
- Backtests for Popular Long & Short Volatility Exchange Traded Products
- Next VXX Reverse Split—April 2015?
- Top 10 Questions About Volatility Investing
- Graphical Representation of CBOE’s VIX Calculation
Thursday, April 10th, 2014 | Vance Harwood