Volatility-linked exchange traded funds that follow VIX futures such as ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) have shown signs of life recently on rising trading volume following the steady descent from October.
A leveraged exchange traded note, VelocityShares Daily 2X VIX Short Term ETN (NYSEArca: TVIX), has seen volume spike in a volatile week.
These volatility-linked products rise when investors are seeking protection in options markets from stock pullbacks. However, it’s critical to remember they track VIX futures contracts, rather than the spot price.
The CBOE Volatility Index, or VIX, is a widely monitored indicator for implied future volatility.
Volatility ETFs can be used by traders to hedge portfolios or speculate on market weakness.
Before diving into this asset class, potential investors should take the time to fully understand how VIX ETFs operate:
- VIX Futures. VIX exchange traded notes and ETFs typically follow a basket of S&P 500 VIX futures. When the VIX rises, it means that investors are anticipating higher stock market uncertainty in the future. Observers will notice that the VIX tends to show a negative correlation to the overall performance of the U.S. equities market.
- Tracking the VIX? Volatility-linked ETFs do not perfectly reflect the performance of the spot VIX. Potential investors need to be aware that the VIX ETNs and ETFs may lag behind the actual performance of the CBOE Volatility Index. The fund products rebalance on a regular basis and may issue negative roll yields – the funds purchase costlier later-dated futures contracts after selling or rolling a futures contract that is about to mature. Additionally, due to the negative role yield, the VIX loses money during times of market stability or extreme volatility. [VIX-Linked ETF Decline Reflects Lower Volatility]
- Short-Term Investments. VIX fund products are not meant as long-term, buy-and-hold investments. VIX futures are meant to act as a hedge or to insure against market volatility. Consequently, the VIX futures curve tends to stay in contango, or show a negative roll yield, over the long run. [Commodity ETFs and Contango]
VelocityShares Daily 2X VIX Short Term ETN
For more information on market volatility, visit our volatility category.
Max Chen contributed to this article.