ETF Univ: Understanding VIX ETFs

January 01, 2020

[This article appears in our January 2020 edition of ETF Report.]

The Cboe Volatility Index (VIX) attracts traders and investors because it often spikes when U.S. equity markets plunge. Known as the fear gauge, the VIX index reflects the market’s short-term outlook for stock price volatility as derived from options prices on the S&P 500.

The challenge is that investors just can’t access the VIX index. Period.

VIX ETFs exist, but they actually track VIX futures indexes, which creates two massive challenges:

VIX ETFs Don’t Reflect The VIX Index
By any measure, VIX futures indexes—and therefore VIX ETFs—do a poor job emulating the VIX index. The VIX index is uninvestable, and over periods of a month or a year, the return pattern of VIX ETFs will differ radically from that of the VIX index.

VIX ETFs Tend To Lose Money—Lots Of It—In The Long Run
VIX ETFs are at the mercy of the VIX futures curve, and they rely on them for their exposure. Because the typical state of the curve is upsloping (in contango), VIX ETFs see their positions decay over time. Decay in their exposure leaves them with less money to roll into the next futures contract when the current one expires. The process then repeats itself, leading to massive double-digit losses over the course of a typical year. These funds almost always lose money long term.

In It for a Minute
In the real world, traders stay in VIX ETFs for one day, not one year. VIX ETFs are emphatically short-term tactical tools used by traders. Products like VXX are incredibly liquid, turning over their entire large AUM in one or two days of trading. Traders speculate with VIX ETFs because they offer the best (or least-worst) means to get at the VIX index in the very short run. So-called short-term VIX ETFs offer better one-day sensitivity to the VIX index then do “midterm” VIX ETFs.

Cboe Global Markets owns the VIX and is the parent company of ETF.com and ETF Report.

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