How Closely Does VXX Track the VIX?

A reader recently asked me about the correlation between the spot VIX and iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX).

I know it’s not exact, but for a 10% move in VIX, how much would VXX move on average?

He is correct; it’s not exact. But, as a general rule, VXX captures about 50% of the daily move in the CBOE Volatility Index (VIX). So, if the VIX moves 10% in either direction, VXX will likely move about 5%, in the same direction.

Why’s that? One word: “mean reversion.” (OK, technically that’s two words, but it is one concept.)

Options traders always anticipate mean reversion from the VIX. That is, what goes up in the very short term, will go back down in the modestly longer term.

VXX tracks a hypothetical 30-day futures on the VIX. A 30-day future simply tells you where Mr. Market expects to see the VIX exactly 30 days from now. It’s a snapshot; it’s not a commentary on the path it will take to get from here to there.

So let’s say the VIX lifts 10%. Does that influence your opinion of where you expect to see the VIX exactly 30 days from now? Perhaps modestly. But would you ramp your bid for a VIX future up 10% on that? Almost certainly not. Rather, you’d find some middle ground between leaving it untouched and anticipating the full 10% lift to hold.

In other words, you price in some sort of mean reversion. If you believe that “mean” really is 10% above the previous day’s VIX reading, you’ll tend to bid up the future. But if you believe the VIX rally is just a blip, you will not bid the future up significantly.

In the short (about 16 month) life of the VIX, these forces have translated to about a 50% correlation on a day-to-day basis. That’s solely a guideline, however, and far from a hard and fast rule.

For example, if the VIX itself is on the high side, VXX will clearly underperform to a greater extent on rallies. Plain and simple, when the VIX is near 40, no one reasonably expects it be higher 30 days from now. Thus, further VIX lifts from there are met with relatively weaker rallies in VIX futures. Conversely, with the VIX near 15, it’s quite the opposite.

Take a look at today’s action. The VXX is only tracking about 25% of the VIX decline. Why’s that?

Well, June VIX futures closed at a large discount to the VIX on Friday. That’s unusual, although it’s something we’ve seen with this VIX surge. All we’re seeing today is a narrowing of that discount. As I type, the June futures are $2 below VIX, down from $6 on Friday.

So, short story long, on average, VXX will move about 50% of the move in the VIX. Just always keep your eye on absolute levels and futures premiums/discounts, as they will cause variance from that general guideline.

Follow Adam Warner on Twitter @agwarner.

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