How low can they go? That’s the seemingly never-ending question about volatility-linked ETFs designed to track CBOE Volatility Index futures.
The iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) is the largest volatility exchange traded product. It is down 68.7% year to date. A leveraged product, VelocityShares Daily 2x VIX Short Term ETN (NYSEArca: TVIX), has shed 92.3% of its value, according to Morningstar data. [Investors Buy Worst-Performing ETFs]
The VIX bounced Tuesday after falling near the lowest level in five years during the previous session.
The volatility exchange traded products won’t replicate the spot VIX because they’re geared to track futures contracts based on Wall Street’s co-called fear gauge.
Some investors use volatility ETFs has a hedge because the VIX has a strong inverse correlation with stocks. In other words, the VIX tends to rise when investors are seeking protection or “insurance” in S&P 500 options.
The VIX briefly dipped below 14 on Monday as fear drops and the stock market continues to churn higher. The index’s long term average is around 20.
Trading volume is extremely low this summer as investors await the next moves from central banks on economic stimulus, according to a report Monday.
“We’re getting to a point where everybody is going to be on hold waiting for some action out of the ECB and the Fed,” said Bruce McCain, chief investment strategist at the private-banking unit of KeyCorp, in a Bloomberg report. “At this time of the year, there are fewer people in the office.”
Although the VIX is Wall Street’s favorite fear index, it does have some limitations as a sentiment benchmark.
“Before trying to use the VIX as a predictive gauge, especially to determine complacency and therefore a sell signal, always keep in mind that the VIX is mathematical calculation and tends to revert to the mean. It is most useful when it reaches an extreme only relative the actual or realized volatility for an extended period of time,” writes Steve Smith at Minyanville.
“Note back in 2005 and 2006 there were a number of periods where the VIX was running in the pre-teen 11 to 12 range,” he said. “But during these stretches the S&P 500’s historically volatility had sunk into the single digits. The market went on to make new highs in 2007 before the wheels came off in 2008 and the VIX rocketed.”
iPath S&P 500 VIX Short Term Futures ETN
Full disclosure: Tom Lydon’s clients own TVIX.