The iPath S&P 500 VIX Short-Term Futures ETN (AMEX:VXX), also known as the Volatility ETF, has been on quite a rollercoaster ride during the past three months. Just today, it’s up almost 17%.
The ride started way back in August, when the VXX sat in the low $20s, clearly on its way to 0. That wasn’t to say that the CBOE Volatility Index (CBOE:VIX) – the market’s measure of short-term volatility — itself would go to 0. But, rather, it simply implied that the structure of VXX was *flawed.*
How the Volatility ETF Works
Just to refresh, the VXX proxies a 30-day VIX future. (In other words, instead of trading the futures directly, you can use a more-familiar vehicle, an ETF, to trade volatility.) So, in order to maintain constant duration, VXX must roll out in time every day — basically from a nearer-month future or swap to a further-out future or swap.
If the further-out VIX future trades higher than the nearer one, then the VXX will lose money every day. And since the nearer-month future *ALWAYS* trades lower than than further one, the VXX would always lose money on the roll.
Except, always didn’t last forever. A funny thing happened. Rather, several funny things happened.
The market tanked, the VIX exploded and, lo and behold, the VIX futures curve flipped into backwardation. (That is, the nearer month traded above the further month.)
And demand for VIX futures overall grew as the marketplace assumed a more-permanent lift in volatility. All of this put a tailwind into the VXX, propelling it to a high of 59 about four weeks ago.
You can see the last quarter-year of VXX on the graph above, with volume and the implied volatility of VXX options using the VIX calculation methodology. (Yes, that’s the VIX of the VXX.)
VXX Volume, Options Volatility Nowhere Near Their Highs
What’s interesting here is that both VXX volume and VXX options volatility peaked very early in the actual VXX rally. Even if you dollar-adjust the VXX volume for the price of the VXX itself (remember, it’s basically a hedging vehicle), volume peaked in August.
VXX options trade at a 95 volatility right now, which sounds high in a total vacuum, but not so much in terms of actual VXX action. Ten-day realized volatility in VXX sits at about 133 as I type … not far off the peak of 149 in August.
So, options at a 95 volatility are not high vs. the action in VXX itself. But that’s not to say VXX will continue to move at a 133 volatility. However, it does say that VXX options are not particularly pricey.
Is It Time For You to Trade Volatility?
Personally, I own VXX calls and puts, and I buy and sell VXX stock against it each day to offset the daily options decay.
Of course, I have that on as a general hedge against regular stock and option positions; I’m not sure I would just put that on alone.
There’s no actual spot VIX that you can buy or sell, so the VXX and VIX futures are the most liquid ways to *trade* the VIX. Neither will fully track the VIX, however. The VXX more or less covers 50% of daily VIX moves, so adjust for that if you play.