I took a fair bit of heat on June 20 when I eviscerated the idea of holding the iPath S&P 500 VIX Short-Term ETN (NYSEArca: VXX) as a hedge for your S&P exposure.
At the time, I pointed out how VIX is itself a pretty terrible measure of volatility. I argued that VXX, which tracks futures on VIX, was pretty terrible even at capturing VIX.
It turns out the timing of my post couldn’t have been more, well, timely, as that same day we saw a near-historic spike in the level of VIX.
You’re reading that chart right. On June 20, VIX opened up 12 percent and closed the day up 25 percent. The S&P was down “only” 2.4 percent on the day. Investors dream of a “hedge” like that—one that will give you incredible downside protection. Unfortunately, that’s not at all that VXX did on that day:
The problem here is that because VXX is tracking futures on VIX, there’s always a dampening effect.
When the VIX spiked in the morning, VIX futures traders now had to price in the likelihood that VIX would stay at that inflated level, and since VIX itself is generally mean-reverting, the futures market usually bets for a return to the mean, and VIX futures didn’t spike nearly as fast or as high as VIX itself did.
So how could investors actually get something approaching the level of VIX if they were magically prescient, read my post before the open, considered me an idiot and then piled into something to hedge their portfolio?
If you haven’t heard of CVOL, you can be forgiven.
The C-Tracks City Volatility ETN (NYSEArca: CVOL) rated a D-51 in our analytics system—a level of “DO NOT BUY THIS” scoring that relegates it to the bottom of pretty much anyone’s list. It rates so poorly for good reasons: It’s expensive, at 1.15 percent. It has just over $2.5 million in assets, making it a coin flip as to whether it will even stay in business. It trades at 2 percent spreads, and just $100,000 a day, on average, changes hands. By really any rational assessment, it’s pretty much unownable.
And it does exactly what volatility chasers want out of an ETP when the vol spiked. Here it is over the whole roller-coaster ride last month:
Not only did CVOL, at its peak, capture essentially the entire move in the VIX that had investors freaking out, it actually held onto those gains far longer than the VIX did.
Magic? No, just math.
Where VXX just tracks front-month futures on VIX—and thus tests Zeno’s paradox in its race to zero over the long haul due to crushing contango, CVOL meanwhile tracks third- and fourth-month futures in order to ease the contango bite and, based on a model, takes a fat short position in the S&P 500 itself.
Here’s the “as close to rational English” version from our reports:
“CVOL's index rolls a part of its VIX futures exposure daily from 3rd month to 4th month, with both months summing to 200%. The index also has variable short exposure to the S&P 500 index ranging from -250% to 0%, reset monthly.”
This strategy mostly works—over time, CVOL has a higher beta to VIX than any other volatility ETP on the market.
Let me be clear, I’m not actually suggesting anyone invest in this thing. If the crazy math doesn’t scare you away, the spreads and volumes probably will. But if you already think I’m an idiot because I don’t like VXX, at least consider why you’re investing in VXX in the first place.
CVOL simply does it better.
At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at firstname.lastname@example.org.
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