Volatility is making a comeback. But with great volatility must come great ways to trade it. And right now, there are a few exchange-traded funds that should be able to weather these volatile waters.
The CBOE Volatility Index (VIX) has been active in recent market action with intraday jumps of 5% to 10%. Why all the volatility?
For one, there’s the death cross, which is what technical analysts call it when the 50-day moving average falls below a 200-day MA.
This formation occurred last Wednesday on the heels of the biggest decline in a month on The Dow Jones Industrial Average. In case you missed the obvious morbid connotation, a death cross is typically seen as a bearish signal.
So is the aging bull market in a temporary dip or is a new bear market beginning to rear its ugly head? No matter what happens, investors can profit from the battle between the bulls and bears with volatility ETFs.
Whether you want to jump on the volatility bandwagon or you just want to add some short-term downside protection to your portfolio, here are three of the best ETFs for a volatile market.
Best ETFs for Volatility: ProShares VIX Short-Term Futures ETF (VIXY)
Volatility ETFs are most appropriate for short-term trading, and ProShares VIX Short-Term Future (VIXY) is among the best in this regard.
VIXY seeks to track the performance of the S&P 500 VIX Short-Term Futures Index. It is important to note that there can be differences between the actual movements of the VIX and the movements of VIX futures contracts.
The CBOE Volatility Index, or “VIX,” is not an index you can invest in directly, and it reflects expected volatility of the S&P 500. However, short-term futures contracts will reflect expected values of the VIX at the respective expiration dates of the contracts.
Volatility ETFs like VIXY are best used as downside protection when stock prices are falling or expected to fall. Another important note to make is that the price movement on VIXY doesn’t have an inverse relationship with the S&P 500. However, VIXY and volatility ETFs like it will generally see gains when the S&P 500 is falling.
For example, the return for from Aug. 6 to Aug. 12 for VIXY was 3.4%, whereas the S&P 500 lost 0.64%.
Best ETFs for Volatility: iPath S&P 500 VIX Short-Term Futures ETN (VXX)
The most popular fund for tracking VIX is iPath S&P 500 VIX Short-Term Futures (VXX).
VXX is an exchange-traded note, which is a relative of the ETF in the categorization of securities. Liquidity is an important quality when trading volatile funds, and VXX is the most liquid with the highest total assets and the highest average trading volume compared to other volatility funds.
ETNs, unlike ETFs, do not hold any underlying assets — they only track an index, which can reduce tracking error associated with ETFs.
But again, be reminded that trading volatility ETFs and ETNs is best reserved for a period of days or weeks and not for longer periods, as returns (but more importantly, losses) can become extremely exaggerated. For example, although VXX was up over 3% from Aug. 6 through Aug. 12, VXX has a year-to-date loss of 50%.
Best ETFs for Volatility: ProShares Short VIX Short-Term Futures ETF (SVXY)
Some volatility ETFs don’t bet on a volatile market — they bet against it. And ProShares Short VIX Short-Term Futures (SVXY) is a good choice for this type of alternative hedge. SVXY seeks performance that is the inverse of the daily performance of the S&P 500 VIX Short-Term Futures Index.
Short-term performance tends to look the opposite of the index. Therefore the fund may be appropriate for investors wanting to capitalize on potential declines in short-term volatility in U.S. equities a month ahead of time.
For example, the one-month return ending on Aug. 12 for SVXY was 18.4%, whereas VIX had near-opposite results with a 19% loss during the same period.
Because periods of volatility are often short-lived, SVXY can be a compelling option for risk-tolerant investors to consider. For example, the majority of 2015 has not been volatile and the year-to-date return through Aug 12 for SVXY was up an incredible 51.1%.
As a final word of caution, volatility funds of all kinds are not for every investor. They should be used sparingly and in limited amounts as an alternative hedging strategy for a diversified portfolio.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. However some of his clients hold AGG. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.