April may be the cruelest month, but March has been pretty bad for volatility exchange traded products designed to track VIX futures contracts.
First, these volatility-linked funds have dropped sharply this month along with the CBOE Volatility Index, which touched its lowest levels since the summer of 2007.
Second, the exchange traded funds and notes have been hit by so-called contango in the VIX futures market.
“We have seen very steep contango recently, with a big premium in the front-month VIX futures and increasing premiums all the way out in later expirations,” writes Chris McKhann at optionMONSTER.
This means that volatility funds lose money on the trade when they “roll” the contracts before expiration to maintain exposure to VIX futures. [VIX ETFs: Beware Contango]
Finally, volatility exchange traded products have suffered a black eye after the well-documented meltdown in VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX). [TVIX Fallout Lingers for Volatility Products, ETNs]
Earlier this month, the VIX dipped below 14 for the first time in five years. The VIX measures the implied volatility of options contracts on the S&P 500. Exchange traded products track VIX futures contracts, rather than the spot price.
Some argue that VIX-based ETFs and ETNs are unduly influencing the VIX futures market, writes McKhann at optionMONSTER.
“The action in the exchange traded products may be helping to drive that steep contango because they sell nearer-month futures and buy later-dated contracts. Some market observers contend that these funds and notes of own all of VIX futures,” he said.
“It used to be that steep contango in the VIX futures meant that smart money was betting on higher volatility in the near future, and they were usually right. But since 2008, and especially since the inception of the VIX exchange traded products 2009, the steep contango has not necessarily preceded equity selloffs,” McKhann added.
FT Alphaville on Wednesday reported that with VIX ETNs, the market tries to anticipate issuers’ hedge purchases.
“They are a big enough player in the market, and you know they have to sell the April future and buy the May, and so you will get in front of that,” a trader told FT Alphaville. “It definitely creates opportunities — you have a big player which has to behave in a certain way at a certain time. We know how much they should be buying and selling at the end of the day and it creates predictable large flows which people can trade around.”
Other exchange traded products designed to rise with VIX futures include iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) and ProShares Ultra VIX Short Term Futures ETF (NYSEArca: UVXY).
iPath S&P 500 VIX Short Term Futures ETN
