Start With Understanding the VIX​

Before trading exchange-traded funds (ETFs) and exchange-traded notes (ETNs) tied to the VIX itself, it’s important to have a clear understanding of what the VIX really represents. VIX is the ticker symbol that refers to the Chicago Board Options Exchange Market Volatility Index.1 While often presented as an indicator of stock market volatility (and sometimes called the “Fear Index”) that is not entirely accurate.​

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VIX is a weighted mix of the prices for a blend of S&P 500 index options, from which implied volatility is derived.2 In plain English, VIX really measures how much people are willing to pay to buy or sell the S&P 500, with the more they are willing to pay suggesting more uncertainty.​

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This is not the Black Scholes model—VIX is all about “implied” volatility and measures the market’s expectations for volatility over the coming 30 days. What’s more, while VIX is most often talked about on a spot basis, none of the ETFs or ETNs out there represent spot VIX volatility. Instead, they are collections of futures on the VIX that only roughly approximate the performance of VIX.​

A Host of Choices​

The iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX)​

While investors will often refer to VIX ETFs, the fact is that the majority of the investments offered are exchange traded notes (ETNs). One of the largest and most successful VIX products is the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX). The ETN was formerly traded as the iPath S&P 500 VIX Short-Term Futures ETN (VXX) from its inception date of Jan. 29, 2009 until its maturity date of Jan. 30, 2019. Previously, VXX had a 10-year maturity, whereas the series B is a 30-year ETN and matures on Jan. 23, 2048.3​

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This ETN holds a long position in first- and second-month VIX futures contracts that roll daily.3 Because there is an insurance premium in longer-dated contracts, the VXX experiences a negative roll yield (basically, that means long-term holders will see a penalty to returns).​

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Because volatility is a mean-reverting phenomenon, VXX often trades higher than it otherwise should during periods of low present volatility (pricing in an expectation of increased volatility) and lower during periods of high present volatility (pricing a return to lower volatility).​​

The iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ)​

The iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ) is structurally similar to the VXX, but it holds positions in fourth-, fifth-, sixth-, and seventh-month VIX futures. Trade the VIX

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Accordingly, this is much more a measure of future volatility and it tends to be a much less volatile play on volatility. This ETN typically has an average duration of around five months and that same negative roll yield applies—if the market is stable and volatility is low, the futures index will lose money.​

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The ETN formerly traded as the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) and had a maturity date of Jan. 30, 2019. The inception date for the series B 30-year ETN was Jan. 17, 2018 and the maturity date is Jan. 23, 2048.4​

The iPath S&P 500 Dynamic VIX ETN (XVZ)​

Investors looking for a midway alternative between VXX and VXZ might look into iPath S&P 500 Dynamic VIX ETN (XVZ). XVZ provides investors with exposure to implied volatility by dynamically allocating positions between both short-term futures contracts and mid-term futures contracts.​

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The returns for XVZ are linked to the performance of the S&P 500 Dynamic VIX Futures Total Return Index. In order to gauge market expectations of future volatility, the index monitors the steepness of the implied volatility curve and uses this information to determine its allocations.5​

The ProShares Short VIX Short-Term Futures ETF (SVXY)​

There is also an ETF for investors looking to play the other side of the volatility coin. The ProShares Short VIX Short-Term Futures ETF (SVXY) is an inverse ETF that seeks daily investment results equal to one-half the inverse of the daily performance of the S&P 500 VIX Short-Term Futures Index.6​

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A critical key for investing in SVXY is to understand that the fund is only intended for short-term trading

and is not a buy-and-hold strategy. SVXY seeks its inverse return from its underlying benchmark for a single

day, as measured from one net asset value (NAV) calculation to the next.6 Investors in SVXY should monitor

and manage their investments daily. Inverse ETFs held for more than a day can lead to large losses.​

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Because inverse ETFs can rack up significant losses quickly, they are designed for knowledgeable investors who should carefully consider their risk tolerance before investing.​

Beware the Lag​

Investors considering these ETFs and ETNs should realize that they are not great proxies for the performance

of the spot VIX. All of these funds can be expected to perform very differently from the VIX. Some may

rise or fall in tandem with VIX, but the rate at which they move and the lag time can make pinpointing

entry and exit points a challenge even for seasoned traders.​

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Market volatility investments are best suited for investors with a short-time horizon who can closely watch

their positions and move quickly if the market turns against them.​ Trade the VIX

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If investors really want to place bets on equity market volatility or use them as hedges, the VIX-related

ETF and ETN products are acceptable but highly-flawed instruments. However, they certainly have a strong

convenience aspect to them, as they trade like any other stock.​

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