Why Volatility ETFs Are Bad Mirrors

03/01/2013 9:00 am EST

Focus: ETFs

John Spence of ETF Trends explains the recent disparity between the VIX volatility indicator and its tracking indexes.

Volatility-linked ETFs were little changed Tuesday afternoon, despite the previous day’s spike and the global equity sell-off on fresh Eurozone debt worries.
However, trading volume in exchange traded products tracking VIX futures, such as iPath S&P 500 VIX Short-Term Futures ETN (VXX), ProShares Ultra VIX Short-Term Futures (UVXY), and VelocityShares Daily 2x VIX Short-Term ETN (TVIX) remained elevated Tuesday.
VXX was fractionally higher for the session, after rallying nearly 14% on Monday. The CBOE Volatility Index was down about 9% at last check, however.

The VIX—known as Wall Street’s fear gauge—soared 34% on Monday, its largest one-day gain in 18 months, as investors fretted over parliamentary elections in Italy and the looming sequestration deadline in the United States.
“Volatility often behaves this way in front of events,” Peter Cecchini, global head of institutional equity derivatives at Cantor Fitzgerald, told Bloomberg News. “It’s as if people who have been sleeping at the wheel suddenly wake up to see the back of a tractor-trailer way too close for comfort, and then they jam on the brakes.”
The performance disparity of the spot VIX and volatility exchange traded products this week is a reminder that VXX and similar products are designed to track VIX futures contracts. Mark Sebastian at OptionPit.com notes that the spot VIX on Monday settled above six futures contracts—every month from March to August.
This unusual action partly explains why VXX was slightly higher Tuesday, while spot VIX slipped 9%.
According to VXX issuer Barclays, the ETN’s index offers exposure to a daily rolling long position in the first- and second-month VIX futures contracts. These futures contracts were little changed on Tuesday even though spot VIX dropped roughly 9%.

Read more from ETF Trends here...
Related Articles:

What You Should Look at After a Vix Spike

Is it Too Late to Join the Party?

The Good, the Bad, and the Ugly of VIX Trading

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