The CBOE Volatility Index, or VIX, is a popular measure of stock market volatility. However, investors should understand the differences between the VIX and VIX futures-backed exchange traded funds.
On the recent webcast (available on-demand), Capitalizing on Rising U.S. Equity Volatility with VIX Futures ETFs, Matt Moran, Vice President of the Chicago Board Options Exchange, said that the VIX measures the market’s expectations of 30-day volatility implicit in the prices of near-term S&P 500 options, or SPX options with more than 23 days and less than 37 days to expiration to provide a 30-calendar day volatility measure. Potential investors should also note that the VIX index itself is not investable.
The VIX fell 6.5% to 15.15 on Tuesday as the equities market rallied on strong earnings results. The index has reflected a relatively complacent market for most of the year, compared to an average VIX value of 19.8 or a median value of 17.9 since January 1990.
In a survey of financial advisors attending the webcast, the majority 55% of respondents believe the VIX could spike to an average 18% to 25% over the first week of November before the U.S. elections, followed by 30% of respondents who believe the VIX could hover around 13% to 17%.
Moran also explained that traders are interested in the VIX because of its high volatility, negative correlation to the S&P 500, convexity or ability to outperform when the S&P 500 declines, and seasonal trends that showed monthly highs for the VIX ranged from an average 22.3 low in May to 29.8 high in October over the past 24 years.
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If investors want to hedge against any market risks or bet on volatile turns, people would typically utilize VIX futures, which are priced based on the forward value of the VIX. Since investors can’t invest in the VIX Index itself, many typically use futures to hedge positions.
To make it easier for investors to gain exposure to the VIX, Joanne M. Hill, Head of Institutional Investment Strategy at ProShares, outlined two indices that try to reflect changes in the VIX through VIX futures contracts, including the S&P 500 VIX Short-Term Futures Index, which reflects expectations for the VIX in one month, and S&P 500 VIX Mid-Term Futures Index, which reflects expectations for the VIX in five months.
Investors should note that VIX futures are not the same as the VIX spot price. However, Hill explained that a VIX futures index has historically been less volatile than the VIX, which may limit risk exposure for traders but also limit potential short-term gains.
“In the last five years, S&P 500 VIX Short-Term Futures Index volatility has been about half that of VIX, ranging from 60% to 80%. S&P 500 VIX Mid-Term Futures Index volatility has been in the range of 25% to 40%,” Hill said.
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Additionally, since the VIX-related indices track futures, the tools may be subject to the negative effects of contango in the futures market. The S&P 500 VIX Short Term Futures Index rolls contracts every day to gain a notional exposure that is always 30 days out. However, since the VIX market is perpetually in a state of contango, where later dated contracts are costlier than near term contracts, the index is selling low and buying high each time it rolls over its contract.
“If the VIX term structure is consistently upward sloping, the return of these futures based indexes will underperform the spot VIX,” Ryan Dofflemeyer, Portfolio Manager at ProShares, said.
Dofflemeyer also outlined a number of VIX-related ETF options to manage market risks, including the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY), ProShares VIX Mid-Term Futures ETF (NYSEArca: VIXM) and ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY). VIXY tracks the S&P 500 VIX Short-Term Futures Index. VIXM tracks the S&P 500 VIX Mid-Term Futures Index. Lastly, UVXY tries to reflect the same underlying index as VIXY.
“The S&P 500 VIX futures indexes are designed such that the mix of futures contracts at any one time maintains a fixed weighted average time to expiration,” Dofflemeyer said. “This is done by rolling a portion of the near contract position out to the far contract position each day. This daily roll may present costs and risks associated with contango and backwardation markets.”
Financial advisors who are interested in learning more about the CBOE Volatility Index can watch the webcast here on demand.