A little more than three weeks out from the U.S. Presidential election, investors are getting jittery about increased volatility levels. Traders are keeping a close eye on the CBOE Volatility Index (INDEXCBOE:VIX), the premier benchmark for U.S. stock market volatility. Today, we will look at three VIX ETFs to trade election volatility.
Volatility measures the change in price and the related risk of a financial instrument over time. When a given asset’s price fluctuates quickly within a short timeframe, then markets regard that asset to be highly volatile.
Recent research on the U.S. Presidential election highlights that, “Political uncertainty and the stock market performance remain the primary anxiety for the market participants, analysts, and policy makers … S&P Capital IQ reports that presidential election cycles have significant economic and behavioral consequences for the stock markets.”
In short, every four years, the U.S. markets experience increased levels of volatility around the presidential election date.
Importance of ‘Fear Index’
The Chicago Board Option Exchange (CBOE) introduced the VIX index in 1993, based on the S&P 500 index. In less than three decades, its popularity among traders has increased exponentially. Many in the markets also regard it as the “fear-index” or “fear-gauge.” It may indeed provide useful information to evaluate broader markets. It may also serve as a hedging instrument to lower portfolio risks.
We are going to spare readers the detailed calculation of the VIX index. In short, the reading gives the market’s expectation of 30-day, forward-looking volatility, implied by the prices of S&P options. On a side note, implied volatility, which is a dynamic number, stands for what the market is “implying” the volatility of an asset will be in the future. This change is based on changes in option prices of the underlying asset.
In general, the CBOE Volatility Index spikes when the S&P 500 declines sharply. On the other hand, during bull markets, the VIX drops steadily. As would be expected, in early March, the VIX shot over 80 and on March 18, it hit a 52-week high of 85.47. The day also saw the 52-week low prices in many U.S.-based stocks. Currently, this forward-looking index is hovering at 25.5.
It’s next to impossible to know the extent of any given market movement beforehand. VIX ETFs may help market participants profit from short-term increases in the expected volatility of the S&P 500, as measured by the prices of VIX futures contracts.
However, before we introduce these VIX ETFs, we have to remind InvestorPlace.com readers that none of these products is an investing product. Instead, as their sponsors and fund managers clearly identify in respective prospectuses, they are mostly designed as short-term trading products that would be appropriate for experienced traders.
With that information, here are the VIX ETFs to trade election volatility:
- Barclays iPath Series B S&P 500 VIX Mid-Term Futures ETN (CBOE:VXZ)
- iPath S&P 500 VIX Short-Term Futures ETN (CBOE:VXX)
- ProShares VIX Mid-Term Futures ETF (NYSEARCA:VIXM)
VIX ETFs: Barclays iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ)
The Barclays iPath Series B S&P 500 VIX Mid-Term Futures (52-Week Range: $16.44 – $42.11) is an exchange-traded note (ETN), or an unsecured debt security usually issued by a bank, such as Barclays (NYSE:BCS). One of the differences between an exchange-traded fund (ETF) and and ETN is the credit rating and risk of the issuer. Therefore if the credit rating of the underwriter were to decrease, then the price of the ETN would also decrease.
Readers may assume globally recognized financial institutions may not have much credit risk. However, we have to remind them what happened during the financial crisis of 2008. As Lehman Brothers collapsed, holders of ETNs issued by Lehman were left with unsecured claims in the global bank’s bankruptcy proceedings.
VXZ provides exposure to the S&P 500 VIX Mid-Term Futures Index Total Return, which gives traders access to equity market volatility through VIX index futures. It holds long positions in differing VIX futures contracts, such as the fourth, fifth, sixth and seventh-month VIX futures contracts.
Put another way, due to the active rolling of several different VIX futures, it is a fairly complicated ETN that could be a useful hedge for sophisticated traders.
iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX)
The iPath Series B S&P 500 VIX Short-Term Futures ETN (52-Week Range: $13.15 – $78.84) is another ETN issued by Barclays. It has become one of the most popular VIX ETFs.
VXX tracks the S&P 500 VIX Short-Term Futures Index Total Return, providing exposure to the value of the near-term futures contracts written on the VIX index.
Fund managers aim to achieve a daily return that exactly matches the daily change in short-term futures contracts tracking the VIX. In other words, VXX’s returns follow the slope of the futures curve. Thus VXX may enable traders who hold bearish views on the market to hedge their portfolios against equity price falls in the short-run.
Traders who plan to use VXX for speculation or hedging should remember that an investment in VXX is not the same as a long-term investment in the VIX. Like other exchange-traded volatility products, it is designed with daily returns in mind. As futures contracts expire, new ones are put in place.
It is rebalanced daily, creating significant effect of the reference index and VXX. As a result, the VIX Index may have positive performance during a given period, while the index underlying the ETN and hence the ETN may experience poor performance.
ProShares VIX Mid-Term Futures ETF (VIXM)
The ProShares VIX Mid-Term Futures ETF (52-Week Range: $19.68 – $50.90) is our last ETF for today. VIXM tracks the S&P 500 VIX Mid-Term Futures index.
With this exchange-traded product, traders have exposure to the returns of a portfolio of monthly VIX futures contracts with a weighted average of five months to expiration. In the past few weeks, we have seen momentum in the S&P 500 begin to wane. Given the current market dynamics, in the short term, such as a few weeks, the VIXM may likely spike.
However, it is hard to know what it might do in the long term. Therefore, we believe VIXM should also be used as a short-term tactical tool by experienced traders.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation.