Sophisticated investors want sophisticated exchange traded funds (ETFs) that cater to their investment whims. But, volatility-related exchange traded notes (ETNs) that need a more acquired taste has come under some scrutiny as to the way the funds track the VIX.
First off, the volatility ETNs use VIX futures contracts, writes Clare White for Optionetics. [VIX ETNs: Calm Before the Storm?]
The iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) holds front month and next month futures contracts. VXX has to roll out the contracts each month as the underlying securities mature. The front month contract percent weight diminishes to zero as the percent weight of the next month rises to 100%.
The iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ) holds futures contracts from months four to seven and also decreases the percent weight in the closest month while the expiration approaches for the front month contracts.
As of October 26, VXX held around 73% Nov. VIX Futures and 27% Dec. VIX futures. The logical way to compare changes in the VIX to VXX would be to calculate the percent change in the two futures holdings and add together. However, on the 27th, VIX rose by 2.42% while VXX increased 1.47%. Similarly, VXZ increased 0.09%, with a calculated component change of 0%.
One may argue that the discrepancy between the price of VXX and its underlying index is due to rolling front month contracts. But in doing so, the VIX daily change as compared to the VXX daily change should be positive, and again this is not always the case on a day-to-day bases, says White.
The daily change in the ETN’s component percent weights and the way the funds roll out contracts with higher or lower values will affect the ETN’s values. The change should be more evident in VXX as compared to VXZ since VXX only has two components and VIX futures tend term structure is more steep in the short-term.
Before investing in these ETNs, be sure to understand what they are created to do and that they fit with your investment goal.
For more information on the VIX, visit our VIX category.
Max Chen contributed to this article.