Investors can utilize CBOE Volatility Index, or “VIX,” linked exchange traded notes to hedge against sudden market swings. However, the investment strategy should not be used as a long-term position.
Robert E. Whaley, credited as the architect of the so-called fear index, stated that VIX ETNs are “not suitable buy-and-hold investments” and are “virtually guaranteed to lose money through time,” reports Brendan Conway for Barron’s.
Whaley points to funds like the iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), VelocityShares Daily 2x VIX Short-Term ETN (NYSEArca: TVIX) and ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY).
Volatility-linked products are designed to track VIX futures rather than the spot price. An investor can’t actually buy the VIX, but anyone can gain access to the Index through ETFs.
Due to the way the ETFs are structured, losses are compounded when VIX futures are in a state of “contango” – longer-dated contracts are more expensive than the front-month contract. As the fund rolls front-month contracts, the ETF sells the maturing contract and purchases a more expense later-dated contract, which could diminish returns over the long run. [VIX ETFs: An Imperfect Hedge]