As the lineup of ETFs continues to grow, more and more issuers have delivered innovative products that tap into strategies and asset classes that were previously hard to reach. One such area that has attracted billions of dollars in assets is the volatility space.
The development of volatility ETPs has been an interesting illustration of the increasingly wide reach of the ETF industry. Unlike stocks and bonds, a direct investment in volatility isn’t possible; the relevant values are derived from prices of other securities, and it isn’t possible to simply go out and buy volatility. Because volatility tends to move in the opposite direction of equity markets, the idea of transforming this metric into an investable asset had obvious appeal to investors looking to bet on a spike in anxiety or to use as an efficient hedging tool in connection with more advanced short-term strategies.
The development of futures and options linked to volatility contracts made such an investment possible–at least for those with the ability to trade and monitor positions in derivatives. The packaging of those securities within the exchange-traded wrapper wasn’t far behind, and that innovation made establishing exposure to volatility as easy as buying shares of GOOG or MSFT.
Appeal Of Inverse VIX
The first VIX ETNs offered long only exposure to an index comprised of futures contracts, and these products quickly became popular among short-term traders as instruments for hedging equity positions or speculating on short term swings in stocks. It didn’t take long for anyone using the VIX products over a longer time period to get a feel for the impact of the futures-based strategy on bottom line returns.
VIX futures markets are often in a state of contango, meaning that long-dated futures are more expensive than those closer to expiration. At the short end of the maturity curve, that contango can be quite steep. That means that the “roll yield” incurred when selling expiring contracts to buy up next-to-expiration futures can be hefty, creating a significant gap between a futures-based VIX ETP and the hypothetical return on a spot investment in the VIX (which isn’t possible).
A number of ETNs effectively give investors a tool to exploit the structural inefficiencies in VIX futures markets that accounted for that huge discrepancy. These inverse VIX ETPs essentially allow investors to play the role of the insurance company, selling portfolio insurance with a relatively high premium. If the big one hits–like it did in 2008–these products are likely to get pummeled by a surge in volatility. But if measures of volatility hold steady or even rise modestly, the wind at the back of these products gives investors a potentially compelling return-enhancement mechanism.
Inverse VIX ETNs
Those looking to establish inverse exposure to the VIX and profit from the same contango that cripples long-only funds over the long run have a number of options to choose from. And while there are some general similarities, many of these inverse VIX ETNs are quite different from one another:
|(XIV )||VelocityShares Daily Inverse VIX Short Term ETN||1.35%|
|(SVXY )||ProShares Short VIX Short-Term Futures ETF||0.95%|
|(ZIV )||VelocityShares Daily Inverse VIX Medium Term ETN||1.35%|
|(XXV )||Barclays ETN Inverse S&P 500 VIX Short-Term Futures ETN||0.89%|
|(IVOP )||iPath Inverse S&P 500 VIX Short-Term Futures ETN||0.89%|
VelocityShares Daily Inverse VIX Short-Term ETN (XIV )
This ETN is perhaps the most efficient tool available for those looking to profit from the steep contango in VIX futures markets. XIV seeks to deliver daily results that correspond to the inverse of an index made up of short-term futures contracts. That focus means that XIV is often hammered when volatility spikes, but should perform well during periods of falling or even flat volatility. Because XIV seeks to deliver the inverse of a futures-based index, it isn’t uncommon for this product to rack up gains during periods in which the spot VIX actually climbs.
Short VIX Short-Term Futures ETF (SVXY )
SVXY is the only fund on this list to offer inverse exposure to VIX futures via the exchange-traded fund structure, meaning it is subject to tracking error. The fund offers -1x exposure to the S&P 500 VIX Short-Term Futures Index, measures the movements of a combination of VIX futures and is designed to track changes in the expectation for one month in the future. The index maintains an average weighted settlement date of one month by rolling a portion of the position in the first month VIX futures contract into the second month VIX futures contract on a daily basis.
VelocityShares Daily Inverse VIX Mid-Term ETN (ZIV )
This ETN also offers inverse exposure to an index comprised of VIX futures, but focuses on a benchmark comprised of securities with a longer time until maturity. The related index has a constant weighted average maturity of five months, which reduces both the volatility and the impact that the slope of the futures curve has on calculated returns. So ZIV will generally experience both single day and multi-period price swings that exhibit near perfect correlation to XIV, but with less volatility. For investors looking to tap into the inverse VIX investment thesis with less substantial risk in the event of a stock market collapse, ZIV can be a useful tool.
iPath Barclays ETN+ Inverse S&P 500 VIX Short-Term Futures ETN (XXV )
XXV debuted in July 2010, and the notes mature in July 2020. The fund tracks an index that is designed to reflect the returns that are potentially available through an unleveraged investment in short-term futures contracts on the CBOE Volatility Index. The Index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects market participants’ views of the future direction of the VIX index at the time of expiration of the VIX futures contracts comprising the Index. Given its methedology, XXV can be subject to the downside effects of contango.
Inverse S&P 500 VIX Short-Term Futures ETN (II) (IVOP )
This iPath fund provides the exact same exposure as XXV. The only difference is that IVOP debuted in September of 2011 and the notes will mature in September 2021.
Be sure to also read VIX ETF Options: Leveraged, Inverse, and More.
The Bottom Line
The nuances highlighted above may seem subtle, but they can have a huge impact on performance. Each of these products has the potential to be a very useful tool or a wildly inappropriate mechanism; that all depends on the risk tolerance and objectives of the individual investor.
Disclosure: No positions at time of writing.