What’s stressing out options traders more than anything else these days? How about the ugly, ugly iPath S&P 500 VIX Short Term Futures ETN (NYSE: VXX)?
The chart below shows VXX since it’s inception at the end of January 2009 (yellow) versus the VIX (black). As you can see, the VIX has lost half of its value, while the VXX lost almost 83% in the same period.
Most people know VXX doesn’t track the VIX exactly, but that can’t explain why VXX goes down just about every day no matter what the VIX does. So what does explain it?
Well, consider the structure of VXX. The price itself is meaningless as far as it relates to the VIX. It’s simply a mathematical creation. VXX listed at $100 with a mission to track a hypothetical 30-day VIX future. Since no such future actually exists, VXX must create one in some form, either by maintaining and constantly readjusting a position in the appropriate listed futures, and/or using third-party swaps.
It does not really matter, though. So long as VIX futures have an upward sloping curve in the nearer term, VXX will lose money every day as it rolls out. We often refer to this as “contango drift,” and this problem also plagues ETFs like the United States Oil Fund LP (NYSE: USO) and United States Natural Gas Fund LP (NYSE: UNG).
That’s just a small piece of the puzzle, though. On an isolated day, VXX simply moves with the futures themselves. For the most part, VIX futures track the VIX well, but we see plenty of exceptions. Among other things, futures premiums rise and fall.
For much of the summer, we noted futures premiums were quite high. Well, guess what? Those premiums have eroded a bit lately. The VIX itself sits near post-flash-crash lows, and lately the realized volatility in the S&P 500 (SPX) does not exactly provide much reason to pay up for options. VIX futures seemed to expect some excitement this fall, but so far, not so much, hence an easing of the premiums paid. And as those premiums erode, so does VXX.
Now, if the VIX futures curve virtually always slopes upward, shouldn’t VXX always have this sort of weight upon its shoulders? Well, yes, I fully expect it to become completely worthless at some juncture. But, no, I would not just short it and forget about it.
At the end of the day, it still depends on the VIX itself. As we well know, the VIX periodically spikes, and futures follow, and thus, so would VXX. So while it will indeed go to wallpaper, it will shake out many shorts along the way. I would rather wait for VXX strength to sell than initiate shorts right here.
Follow Adam Warner on Twitter @agwarner.
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