For the average investor there are three, not so attractive ways to go long on VIX:
- Buy Barclays’ VXX (short term) or VXZ (medium term) ETNs or one of their competitors (8 as of January 2011) that have jumped into this market. See volatility ticker for a full list.
- Buy VXX or VXZ call options (recently ProShares VIXY and VIXM began offering options too)
- Buy VIX call options / short VIX put options
The first one, buying volatility ETNs like VXX, is the simplest—anyone with a brokerage account can do this. Be aware that the VXX will definitely lag the VIX index (think molasses), and it is not suitable as a long term holding because the people in the VXX shop are forced to continually shift from short term to longer term futures contracts, usually at unfavorable rates.
Some VXX closing values compared to the VIX index:
- Its first day of trading, 30-Jan-09, VXX closed at 104.58, the VIX index closed at 44.95
- December 2009 VXX had dropped to 38, a 63% decline, compared to the 50% drop in the VIX index value to 22.
- 8-September-2010, VXX closed at 19.25, VIX at 23.25. It’s now higher than VXX.
- 12-January-2011, VXX closed at a reverse split adjusted 8.31 v.s. a VIX value of 16.24.
- VXX vs VIX index, click to enlarge
This is a substantial tracking error. Given its dismal track record it is surprising that VXX usually trades over 10 million shares a day. I think the allure comes from its reliable negative correlation with the equity markets. 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 weirdities–such as European exercise, different expiration dates, VRO based settlement values, and greeks that are general wrong. VXX options have an actual underlying, which avoids the perpetual confusion associated with VIX index, and the VIX options where volatility futures are the actual underlying. VXX weekly options are also available.
- 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, frankly I’d look elsewhere (e.g., long term out of the money puts), because these two choices are expensive if you are trying to get enough leverage to really protect a long portfolio.
