Volatility exchange traded products such as iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) have seen inflows and increased trading volume during this week’s stock pullback.
Some traders use these products to hedge long portfolios or even speculate on equity sell-offs.
However, investors need to keep in mind that these ETFs are designed to track CBOE Volatility Index futures contracts, not the VIX spot price. It’s a very important difference.
VXX was up for the second straight day on Thursday, gaining about 11% from Tuesday’s close. However, spot VIX was up about 23% from Tuesday’s close in early trading Thursday. [Dow 14,000: The Death of Volatility ETFs?]
Other volatility ETFs include VelocityShares VIX Short-Term ETN (NYSEArca: VIIX), VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX), ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY) and ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY). Some of the products provide leverage on a daily basis.
Adam Warner at Schaeffer’s Investment Research cautions against using volatility-linked products to try to catch the bottom in VIX.
“You can’t actually buy the VIX,” he writes. Instead, traders can purchase the volatility ETFs that are based on VIX futures. [VIX ETFs: Beware Contango]
The problem is that longer-dated VIX futures contracts are progressively expensive.