Lately, we’ve seen an uptick in volatility in the markets. One minute, they’re up 100 points, the next they’re down 50. What’s an investor to do? One option is to hedge volatility with a pair of exchange traded notes (ETNs).The possible threat of health care intervention, moves from China to restrict credit and harsher regulations of the financial sector in store has created some volatile markets. Gary Gordon for ETF Expert explains that there are designed to hedge these wild price swings. [Why else would an ETN suit a portfolio?]

These ETNs are for short-term investing and can be useful when the market is merely bracing for a correction.

When considering the VIX ETNs, it is imperative to know how they work.  They don’t track the VIX; what they do is track a basket of volatility futures and produce a negative return where the yield on the cash that serves as collateral for the futures softens the blow. [More about the VIX.]

For more stories about ETNs, visit our ETNs category.

These ETNs can help you avoid liquidating holdings with adverse tax consequences for selling:

  • iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX)

  • iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ)

Here are a few differences between ETNs and ETFs [More on ETFs and ETNs.]:

  • ETNs are dependent upon the credit of the underlying bank; ETNs are a structured note, created as a senior debt note by a bank. This means if the bank goes under, you’ll have to get in line with the other creditors.
  • Any tracking error in the ETN is paid for by the issuer; there’s no risk of tracking error on the part of the investor.
  • ETFs can make yearly capital gains (although this is very rare) and income distributions. With ETNs, taxes are deferred until the note is sold or matures.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.