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8 VIX Trading Myths Debunked

When it comes to the VIX, nothing trades quite like you think it should

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VIX Myth #5: You Can Chart VXX Like a Stock

Reality. Since VXX trades like a stock, you may think you can chart it like a stock. Wrong. Run, don’t walk, from anyone who tells you about a key chart point on VXX. The VIX is a statistic, and VIX futures trade based on estimates on a forward price for that statistic. VXX creates a hypothetical constant duration 30-day VIX future and, therefore, loses money each day simply rolling from the nearest month future to the next month out if the next month out trades at a premium. Hence VXX is really just a number relative to itself the day before. It’s the tail of a tail of a tail of a dog.

VIX Myth #6: Holding VXX Can Protect a Portfolio

Reality. VXX works fine as a short-term trading vehicle. On a day-to-day basis, it will track about 50% of the VIX move. However, it is terrible as a portfolio hedge for the reasons listed before, namely that it loses money over time in an upward sloping VIX term structure. Owning and rolling two- to three-month VIX futures works better.

VIX Myth #7: VXZ is a Good Portfolio Hedge

Reality. The iPath S&P 500 VIX Mid-Term Futures ETN (NYSE:VXZ) is similar to VXX, but it tracks four- to seven-month VIX futures instead of 30-day VIX futures. VXZ has done relatively well since its inception and has outperformed VXX by a wide margin. But while it doesn’t have the contango trouble of VXX, the VIX curve gets pretty flat out that far. I would also caution that VXX and VXZ only listed in January 2009, and thus, neither has had to show its mettle through a VIX storm. Four- to seven-month VIX futures almost always hold their premium to the VIX, but would move to a significant discount in a serious VIX explosion. In 2008, they lagged by 20-30 points. So I suspect VXZ would not provide great protection when you wanted it most. It’s a fine volatility proxy in a quiet market, but if the goal is insurance, it may disappoint.

VIX Myth #8: High VIX, VIX Call Buying is a Signal to Get Out or Get Short

Reality. I don’t agree with the above, but I can’t actually prove it wrong. I will say this though, the VIX is a mean-reverting statistic. A high VIX and excessive VIX call buying (and actual SPX put buying) represent extreme nervousness and/or bearish sentiment. In theory, that’s a time you want to buy, not sell. But take that with a grain of salt, because trends do take on a life of their own, like the VIX explosion and market implosion of 2008.

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