Time To Buy VIX ETNs?

by on April 9, 2012 | Updated April 11, 2012 | ETFs Mentioned:

After the best opening quarter in 14 years, skepticism is beginning to grow on Wall Street. Many investors fear that we will be unable to maintain the growth that equity markets have enjoyed, as a number of factors combine to give a cautious outlook. For starters, the Fed’s commentary that the economy needs to grow more to support the current unemployment levels is worrisome along with little mention of QE3. While many argue over the need for another round of quantitative easing, it is clear that markets are pulling for the Fed to ride to the rescue and bolster bullish momentum [see also How The VIX ETN Lost 50% In 48 Hours].

As gas prices continue to climb and uncertainty for our economic future mounts, many investors are growing anxious of the upcoming quarter, as we have already gotten off to a rocky start. For those who feel that more volatile days are on the way, there are two ETPs to help you take advantage of rapidly-developing trends in general equities [see more at our Low Volatility ETFdb Portfolio]:

  • S&P 500 VIX Short-Term Futures ETN (VXX): VXX has quickly made a name for itself, as it is among the most active ETFs in the world, with an ADV topping 46 million. The fund utilizes a front-month roll strategy on VIX futures, meaning that it will fall prey to contango, which generally infects VIX curves. But when markets are headed south, VXX shines bright, taking full advantage of volatile trading. In the months of August and September of 2011, when markets were plagued with instability, this product jumped by more than 143% [see also Early ETF Stars Of 2012].
  • Daily 2x VIX Short-Term ETN (TVIX): TVIX has gotten a lot of unwanted attention in the last few weeks, as mysterious trading led to massive losses in the fund (which had been trading at a large premium). But if you are looking to make a bet on markets headed south, this fund will deliver jaw-dropping returns. TVIX offers a 2X leverage on the same VIX futures as VXX. Over the same period of instability last year, TVIX jumped by 377% before crashing back to earth. Note that the fund is still trading at a premium of 8% or so (depending on market conditions), so investors would do well to keep a close eye on the NAV and market price of this product.

A word of caution, these products can be extremely dangerous. They are not meant for “buy-and-hold” investors, but rather for traders who fully understand their complexities. For those daring enough to make a bet with these funds, stop-loss orders are a must, as watching one of these product move anywhere from 5%-10% in a single trading session is not uncommon. It is also important to note that these two funds have had abysmal years, as volatility has been contracting for quite some time now. However, if markets do take a dive, these funds are the place to be and can provide monster returns [see also Inverse VIX ETN (XIV) Gets Hot Again].

For those who think that markets will continue in their profitable ways, you can also utilize several inverse VIX products like XXV and XIV among others.

Disclosure: Long XIV.