Volatility-linked ETFs tracking VIX futures contracts are notorious for vaporizing big chunks of investor capital with the funds losing most of their value in recent years.
For example, the $1.3 billion iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) was down 70% for the trailing year through June 19, according to Morningstar. [Top ETF Wealth Destroyers]
Volatility exchange traded products are designed as short-term market hedges, although they won’t exactly replicate the spot VIX because they follow futures contracts based on Wall Street’s “fear gauge.”
VXX was up nearly 8% on Thursday as the Dow plunged more than 200 points in the wake of Federal Reserve Chairman Ben Bernanke’s comments that the Fed could pare back its bond purchases later this year.
The VXX rally appeared to have burned some traders who were betting against the volatility product with short positions.
“There’s still a gigantic amount of shorting going on in the market’s volatility exchange traded funds and notes,”Brendan Conway at Barron’s reported earlier this week. “It amounts to a bet that market volatility is going down, or at least nowhere fast — and by inference, the stock market must be in good hands.”
The short interest in VXX is 86.2%, according to XTF.
Next page: ‘Profits can evaporate quickly’
Other volatility exchange traded products 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. [VIX ETFs: An Imperfect Hedge]
“There’s been a persistent downtrend in ‘long volatility’ trading vehicles since 2011,” Conway said. “But volatility has a tendency to skyrocket quickly. Think August 2011. So the trend, and any profits premised upon it, can evaporate very quickly.”
Morningstar ETF analyst John Gabriel on Thursday tweeted that the short traders are likely trying to profit on the massive “negative roll” yield in volatility products. They are not necessarily betting on falling volatility, he added.
“This ETN is designed for use as a tactical trading tool, with prospective holding periods to be measured in days, not weeks,” Gabriel wrote in a profile of VXX. “This is because holding this ETN exposes investors to excessive drag on their portfolios due to the sharp negative roll yield related to rolling futures as they near expiry.”
Volatility products are designed to “roll” the contracts over periodically to maintain exposure to VIX futures. They can lose money on this trade when longer-dated contracts are more expensive than the front-month contract, or when markets are said to be in “contango.” [VIX ETFs: Beware Contango]
iPath S&P 500 VIX Short-Term Futures ETN
