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Do VIX ETNs Make Good Portfolio Hedges?

I have traded VIX ETNs on the long side for the past month or so and actually lived to tell about it. I mostly used calls on the iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ), but I even went long the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) despite my noted disdain for the product.

Was I just trying to be one of the cool kids and hang with the popular VIX crowd? No, I wasn’t succumbing to peer pressure. I did this on my own volition, using the VIX ETNs as a hedging tool, and I can’t really complain about the outcome.

Please be aware that results may vary. Perhaps it just fit my personal strategy. I generally sell puts and put spreads, which gets me long the market and short volatility. Therefore, I am exposed to a market sell-off and/or a volatility surge. So owning positions that somewhat proxy long volatility can help to offset that.

Of course, they don’t always proxy long volatility. VXZ won’t necessarily rally much into a volatility lift. It tracks four-to-seven-month VIX futures, which may or may not fully react to rises in VIX. And VXX gets clubbed almost every day the near-term VIX futures structure slopes upwards.

But what I’ve found is that they do follow a similar trajectory to a simple put option. On a given day, they most likely rally on a market decline. If they don’t, it generally means volatility itself has not reacted much to the market move. And that’s fine, because if volatility itself has flatlined or declines, then the puts and put spreads I am short have done relatively well given the market conditions. 

Over time, VIX ETNs drift. But so do put options. With the puts, its time decay, whereas with the VIX ETNs, it’s what we call “contango drift.” They lose money perpetually rolling out to higher priced VIX futures. They also lose money as VIX futures premiums themselves erode. So even though time decay and contango effects are two different animals, the end result is very similar.

So, am I a VIX ETN convert? No, I still don’t like VXX and VXZ as a general portfolio hedge if that portfolio is simply long stock. VXX, and to a lesser extent VXZ, are ultimately decaying assets. But if you offset the ETNs with another decaying asset, long versus a short put position, they work much better.


Article printed from InvestorPlace Media, https://investorplace.com/2010/12/do-vix-etns-make-good-portfolio-hedges/.

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