Any investors who are using volatility-linked exchange traded products as long-term portfolio hedges are getting hurt by so-called contango in the CBOE Volatility Index (VIX) futures market.
“VIX futures have been mired in contango for some time, where distant month futures are priced higher than front month futures and thus the ‘roll’ effect when the funds rebalance their futures upon expiration results in damaging losses for the funds tied to the VIX and rebalanced in this fashion,” said contributor Paul Weisbruch at Street One Financial in a recent article. [ETF Chart of the Day: VIX]
Investors need to remember that these products are designed to track VIX futures, not the spot price. [3 Things You Need to Know About VIX ETFs]
Exchange traded products that track volatility have declined sharply along with the VIX. They include iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), ProShares Ultra VIX Short Term Futures ETF (NYSEArca: UVXY) and VelocityShares Daily 2X VIX Short Term ETN (NYSEArca: TVIX).
“With the huge contango in the VIX futures term structure at the moment, anyone who is buying VIX options or the VIX exchange traded products right now is having to pay for that contango in order to have the opportunity to capitalize on increasing volatility,” according to the VIX and More blog. The contango-based negative roll yield “means the cost of a volatility hedge for long equity positions is extremely expensive in the current market.” The blog recently noted that Barclays ETN+ VEQTOR ETN (NYSEArca: VQT) and iPath S&P 500 Dynamic VIX ETN (NYSEArca: XVZ) “attempt to minimize the impact of the negative roll yield by using a market timing mechanism that dynamically adjusts the long volatility exposure.” [A Unique Volatility-Linked Product]
Volatility-linked ETFs have grown very popular in 2012 with investors scrambling for portfolio hedges. [VIX Touches 5-Year Low]