You probably don’t need me to keep reminding you that the number of VIX trading products keeps growing. And it seems they are growing in popularity, as well. For example, on Tuesday, we saw a three-month high in volume for the iPath S&P 500 VIX Short Term Futures ETN (NYSE: VXX).
So what’s next? Coming soon: weekly VIX options, and they can all be traded at a brand-spanking new pit on the CBOE.
But what I think they really need is a new VIX ETN. We currently have VXX, which proxies a constant duration 30-day VIX future, and iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ), which tracks a four-to-seven-month VIX future. But what about something in the middle, say 60-90 days?
We know all too well the flaws in VXX. It will surely rally if/when the VIX itself ever lifts, but so long as we have perpetual premiums in futures and an upward sloping yield curve, VXX is ultimately doomed.
VXZ gets less press. It has actually held up quite well despite spending most of its existence in a “heavy” VIX world. Futures out four to seven months don’t respond to each and every VIX tick. The plus side of that is that they stay relatively well bid in the face of VIX declines like we are seeing now. With VIX at roughly 22.5, January VIX futures trade at 30, while April VIX futures trade at 31.5. In addition to maintaining an almost permanent premium to VIX, they vary little from each other; ergo none of the “rolling” issues VXX faces.
The drawback of VXZ becomes apparent during VIX explosions. It just won’t come close to keeping up. We don’t know exactly what will happen since timing is a factor, but below is a chart of VXZ during the only significant VIX jump in the past 20 months, which occurred in May.
The VIX lifted 120% at its peak, while VXZ was only up 28%. That’s a problem seeing as these VIX products exist ostensibly to either insure a portfolio against a market drop, or aggressively benefit from one. You would have to wildly overload on VXZ to accomplish that.
So that’s why I propose they add a 60-90-day VIX futures ETN. VIX futures premiums tend to precipitously decline once they get within a month or so of expiration. That kills VXX but would have no effect on a 60-90-day VIX futures ETN. These futures also tend to trade close to each other in terms of price. Right now, October VIX futures trade near $24.50, while November futures are around $27.50 and December are near $28.50.
On top of getting bashed by the overall decline in VIX futures premiums, VXX has to roll from October to November every day to maintain its duration, thus forcing it to absorb a $3 hit. A 60-90-day ETN would lose $1 or less in this situation.
What’s more, this hypothetical ETN would track the VIX itself more closely than VXZ for the simple reason that the nearer the future, the better it tracks the underlying.
My new ETN is in no way perfect — no product will behave exactly as you would like it to — but it could mitigate some of the flaws of the current VIX ETNs.
Follow Adam Warner on Twitter @agwarner.
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