Every few months a major news outlet will run a story on how some investors lost money because they didn’t understand how contango affects exchange traded products designed to track futures contracts.
Although some of these products are very complex, it could also be argued that investors who don’t do their homework deserve at least some of the blame. The bottom line for investors is that it’s always important to fully understand a fund before the purchase.
On Wednesday, Bloomberg News told the story of 34-year-old pilot and day trader Ian Mathers, who says he “got burned” by a Barclays exchange traded note, iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX).
“Mathers bought the Barclays note expecting it to move in lock-step with spot VIX,” Bloomberg reported. “Instead, the note tracks futures contracts, which means it won’t necessarily match the performance of that gauge.”
Volatility-linked products can be hurt by contango in futures markets, when later-month contracts are more expensive than the current contract. Some commodity ETFs are also susceptible to this condition in futures markets.
The prospectus for VXX warns contango can hurt the ETN and result in negative “roll yields.”
VXX is trading near its 52-week low as a falling VIX suggests investors are less fearful about a potential correction in stocks. [Volatility Shunned as VIX ETN Nears One-Year Low]
VXX is the largest volatility exchange traded product with a market cap of about $1.8 billion. It is structured as an ETN, although there are also ETFs designed to follow VIX futures, such as ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY).