Tuesday, February 23, 2010
TO VXX OR NOT TO VXX
An important concept in financial markets is volatility. The most common measurement of market volatility is the CBOE volatility index, which has a ticker symbol of VIX. While the details of how volatility is measured can be complicated, it can generally by thought of as a measurement of perceived market risk going forward. If the VIX is high, it implies that market participants believe the chance of a falling market is high, and therefore they drive up the price of protective options. In other words, if the VIX rises, it implies an anticipation of falling stock prices.
It is not possible to invest in the VIX directly; however, Barclays has two exchange-traded notes which attempt to follow the VIX via a daily rolling long position in VIX futures contracts. The VXX tracks the forward 1-2 months of VIX futures contracts, while the VXZ tracks the 4-7 month contracts.
How closely do these instruments track the VIX? The answer is, not well.
From January 2009 through February 2010, the VIX fell ~55%.
Over the same period, VXX fell 74% and VXZ fell 32%.
What about performance during a shorter time period, when the VIX was rising?
From 11 January 2010 to 5 February 2010, the VIX rose 73%.
Over the same period, VXX rose by 19% and VXZ rose by 9%.
The conclusion is that neither instrument follows the VIX closely. VXX could be used for short term hedging applications, as Barclays suggests. VXZ is probably more appropriate for medium term time cycles, and appears to underperform the VIX in both the short and longer term, and when the VIX is both rising and falling.
It is not possible to invest in the VIX directly; however, Barclays has two exchange-traded notes which attempt to follow the VIX via a daily rolling long position in VIX futures contracts. The VXX tracks the forward 1-2 months of VIX futures contracts, while the VXZ tracks the 4-7 month contracts.
How closely do these instruments track the VIX? The answer is, not well.
From January 2009 through February 2010, the VIX fell ~55%.
Over the same period, VXX fell 74% and VXZ fell 32%.
What about performance during a shorter time period, when the VIX was rising?
From 11 January 2010 to 5 February 2010, the VIX rose 73%.
Over the same period, VXX rose by 19% and VXZ rose by 9%.
The conclusion is that neither instrument follows the VIX closely. VXX could be used for short term hedging applications, as Barclays suggests. VXZ is probably more appropriate for medium term time cycles, and appears to underperform the VIX in both the short and longer term, and when the VIX is both rising and falling.
# posted by MATT E @ 3:11 PM 
