Tuesday, April 21, 2009

Lost in Translation: VXX and VXZ

Partly based on some thinking I laid out last week in Some VIX Milestones…and a Prediction, I was fortunate to be long VXX, the iPath S&P 500 VIX Short-Term Futures ETN, going into yesterday’s session.

VXX notched a nice one day gain of 7.40%, but this was less than half of the 15.44% gain in the VIX. On the other hand, VXZ, iPath S&P 500 VIX Mid-Term Futures ETN, which targets VIX futures approximately five months out, moved a mere 3.41%, less than half of VXZ. As shown in the chart below, VXZ’s jump did not even match that of the 4.28% drop in the SPX.

All things considered, these are about the percentage moves relative to the VIX that one should expect. I have previously discussed the relative juice factor in VXX Data Now Painting an Accurate Picture and elsewhere, but apparently not everyone has internalized this information yet. Further, if you follow any of the term structure discussions here, the volatility predictions as a function of months into the future is a recurring theme.

With almost three months of data to draw upon, VXX is now averaging close to 50% of the daily move in the VIX and VXZ is averaging approximately 20% of the daily move in the VIX. The bottom line is that if you are looking for the type of moves generated by the cash VIX, your best bets are VIX options, VIX futures or a 2x leveraged play on VXX.

Personally, I find VIX options to generally be the most attractive way to trade the VIX, given their liquidity and the flexibility inherent in structuring a wide range of options positions.

[graphic: VIXandMore]

Disclosure: Long VXX at time of writing.


Eric said...

Well, we broke above 40 at the open. My Range is still in tact, but I have no idea where to go from here.

TraderMike said...

Thank you once again for a great blog: I learn something here every day. My question is the following: Since the vix options are traded with the vix futures as the underlying, wouldn't the VXX be a near perfect hedge for the front month Vix options since the VXX will be mostly comprised of the movement in the front month futures contract?


Bill Luby said...


My crystal ball is getting a little fuzzier too. I am thinking of switching to watch and wait mode.


Thanks for the kind words. If this is the same blogger that appears on my blogroll, you should know that you were one of the original four blogs on my blogroll when I started blogging; needless to say, I am a fan of your work as well (and was a few years ahead of you at your alma mater.)

Regarding VXX as a hedge for front month VIX options, this is indeed as good a hedge as I can think of. For all I know, VIX options market makers may already be using VXX as a hedging tool.

Further on down the line there may be VXX options to contemplate, but until then, linking VIX options to the VXX ETN opens up some interesting strategic opportunities.



Eric said...

Actually, I am watching Nasdaq for a rollover (I was fuzzy until about 3:57pm). I bought AAPL $105 Puts into the close. That is where the strength has been and it seems to be running its course. Even if we spike on an AAPL upside surprise, I think tech will pullback in the next week.

Eric said...

Well, everyone is beating earnings, I hope this is baked in.

Chad said...

Great blog! You and Adam are really doing a lot to piece the VXX together.

I have an issue with your post however. I'm just now doing some research on the VXX and VXZ as possible hedges. It is true that the VXX only rallied 7.4% but the May futures contract rallied 7.9%. The ETN is based on the futures contracts. So, I think you're misleading the reader about the expectations of the VXX. If I have my math right, the fund is tracking its target quite well.

As you and Adam have noted, the VIX cash is very much a real-time indicator, while the futures are priced by expectations as much as current/cash vix.

The discrepancy between futures and ETN seems to be with the contango issue - which you've pointed out numerously, and possibly other small issues I'm currently unaware of now.

I believe the April futures would've been trading for the 20th in question. Seeing how its one month later, I don't know how much the April contract tracked the cash - I would think that would be very close considering it would've been close to expiring. And, if it did, assuming that VXX still had, what? 3 days invested in the April contract - that should've "juiced" the return more so for that day, yet, it still underperformed the may contract by .5 % - based on my calculations.

Regardless, I think the ETN is doing its job quite well.

Bill Luby said...

Well said Chad. I also believe that VXX has done its job quite well -- relative to its target and components.

My main point is that many investors have not internalized that VXX (and VIX options) are not going to move in concert with the cash/spot VIX, but rather VIX futures.

If expectations are based on the futures, then there should be very little disconnect, but this is often not the case.



Michael said...

Hi Bill,

Has been puzzle abt the relationship between vix cash and vix futures. Vix futures always mvoe less quick than vix cash. However when putting up a chart of vix futures front month chart, esp in year 2006 when S&P500 move up smoothly, the vix futures move down smoothly. The total move point is 400 points. Divide with 10and that would gives 40 points for rescaling. For the same period the cash vix move down 20 points. When vix cash is moving up, the futures vix does not even move up at the same percentage giving futures vix a sort of trend. The futures front month vix chart is really like trending market rather than like the cash vix which varies up and down between 0 to 50.

Michael said...

Bill do you think such trend in vix futures would appear again when S&P500 move up smoothly in future?

Anurag Jain said...

Great blog. I just came across your blog, and enjoy reading it. Keep up the good work!

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