Volatility-linked exchange traded products plunged on the last day of the year on heavy volume as President Barack Obama said a fiscal cliff deal was in sight but not yet finalized before the midnight deadline.
The iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX) was off nearly 10% in afternoon trade to end a sharply lower year. The exchange traded note was down 75% for 2012 heading into Monday’s trading despite a recent rebound along with the CBOE Volatility Index, or VIX. The fund and others like it are designed to track VIX futures contracts.
Political posturing and Congress dragging its feet have made investors skittish as the country heads into the so-called fiscal cliff. Consequently, the CBOE Volatility Index, along with related exchange traded funds, surged higher in recent sessions, reflecting the market’s growing fears.
However, the VIX nosedived about 20% on Monday with markets apparently expecting a last-second deal on the fiscal cliff.
The VIX is widely used as a gauge for investor sentiment in the equities market. Exchange traded products that track VIX futures allow investors to capitalize on rising volatility or hedge against short-term uncertainty, such as the current dilemma over the Congressional impasse. [CBOE Volatility Index (VIX)]
For the most part, the index has been widely used as a measure of market risk, acting as a key barometer of investor fear and confidence in the markets. Typically, a high VIX reflects the spiking investor fear in the markets, and a low VIX mirrors investor complacency in a calm market.
With the VIX breaking through its psychological 20 barrier, investors are beginning to feel a little uneasy – the index has historically shown an average between 15 and 20. However, this mark is only viewed as a cautionary point as the VIX can surge higher if the markets believe a deal will not pass through and if the economy will fall into a recession. [Volatility ETF Trading Volume Explodes as VIX Cracks 20]
To put this in perspective, with the debt ceiling debacle and Eurozone crisis coming to a head during late summer of 2011, equities plunged and the VIX crossed over 45. During the height of the 2008 financial downturn, the VIX almost topped out at 90.