VIX exchange traded funds (ETFs) and exchange traded notes (ETNs) are once again part of the conversation as conflicts in Libya and the broader Middle East intensify.
The VIX – otherwise known as the market’s “fear gauge” – jumped to their highest point all year today. The index is a measure of how scared investors are feeling, so when it jumps on days like today, there’s some nail-biting going on.
The index has an inverse relationship to the markets, meaning that it tends to rise when stocks decline. So when the markets declined yesterday and today, the VIX went soaring as much as 30%, says The Wall Street Journal.
Understanding VIX Products
The jump has re-ignited interest in VIX-tracking products, though many investors may not fully understand how they work.
Randy Warren, chief investment officer at Warren Financial Service, points out that the funds are designed for individual investors. But not just any individual investor: the kind who has the time to monitor the funds every day, has a firm grasp of how they work and doesn’t intend to buy-and-hold them.
“You have to decide when to be in and when to be out,” Warren says. That’s because the funds, like all leveraged and inverse ETFs, have the potential to be volatile in very short periods of time.
It’s also important to have at least a basic understanding of futures and options. Like commodity ETFs, VIX futures can be in contango, which is when the spot price is lower than the futures price. In that situation, when current contracts are sold and new and more expensive ones are purchased, it can result in a loss.
It all comes down to educating yourself.
Knowing the Market
“The thing to do is understand what is is you’re buying and the reaction of what the market you’re going to buy is going to be,” Warren says.
Buying the VIX as a hedge in volatile markets is a useful application, but Warren cautions investors who think that they’ll make money on the products.
“If you think the VIX is going to go up in value, you think the stock market is going to go down in value,” says Warren. It all comes down to understanding which side of the bet you’re taking and what its impact could be on your portfolio.
VIX Products Available
The number of VIX products has rapidly expanded in the last year, allowing investors to take a variety of stances on the direction of the index. ProShares came to market with the first VIX ETFs earlier this year with ProShares VIX Short-Term Futures (NYSEArca: VIXY) and ProShares VIX Mid-Term Futures (NYSEArca: VIXM); until then, the products had all been ETNs. Here’s the difference between ETFs and ETNs.
VelocityShares has a series of ETNs tracking the VIX, which are issued by Credit Suisse. They range from the inverse VelocityShares Daily Inverse VIX Short-Term ETN (NYSEArca: XIV), to the long-only VelocityShares VIX Medium-Term ETN (NYSEArca: VIIZ) to the leveraged with VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX).
iPath and UBS also offer leveraged and inverse VIX funds, such as iPath S&P 500 VIX Short-Term Futures (NYSEArca: VXX), iPath Inverse S&P 500 VIX Short-Term Futures ETN (NYSEArca: XXV), and UBS E-TRACS Daily Long-Short VIX ETN (XVIX).