Investors Wonder How Long Volatility Will Stay Muted

The stock market may seem perpetually manic, but not according to one of Wall Street’s most-followed indicators. And that may create a giant profit opportunity during 2023. 

The Cboe Volatility Index, or “VIX,” was introduced 30 years ago, to measure how volatile investors expect the S&P 500 index to be over the next 30 days. It is nicknamed the “fear gauge,” a proxy for current investor nervousness.  

As a rule of thumb, a VIX of 16 implies an expected daily average change in the S&P 500 of 1%. Low volatility markets tend to exhibit a VIX in the 10-15 range, while high volatility markets are characterized by a VIX of 30 or higher.  

VIX has often hovered between 10-17 during periods of relative calm (e.g., 2013-2019). But as in past market crises, it spiked at the onset of the pandemic, and stayed elevated in the 20-35 range for much of 2020-2023 … until very recently.  

On May 15, VIX closed at around 17, and recently traded at its lowest point in well over a year. Is all well? Or is the market just setting up for 2023's version of "shock and awe" this summer?  

A growing set of exchange-traded funds allow investors to use volatility itself as an asset. Note that these ETFs themselves can be extremely volatile, and have tax-related features investors should be aware of when considering them. Since one can’t buy or sell VIX directly, these ETFs use the futures market to establish their positions. 

ProShares offers a pair of ETFs that are essentially opposites, but due to the math of volatility and investment loss, they don’t perform as mirror images of each other. The ProShares VIX Short-Term Futures ETF (VIXY) aims to profit from rising volatility by buying the next one to two months’ VIX futures, while the ProShares Short VIX Short-Term Futures ETF (SVXY) offers a way to profit from a falling VIX by shorting one- to two-month VIX futures. Both funds have more than $225 million in assets under management.  

ProShares also offers the much smaller ProShares VIX Mid-Term Futures ETF (VIXM), which uses the same concept as VIXY, but holds longer-dated VIX futures contracts (three to six months). That makes VIXM less volatile than VIXY and SVXY, but still much more volatile than most equity ETFs. 

Finally, the Simplify Volatility Premium ETF (SVOL) goes both ways on volatility, buying and selling a combination of VIX futures to produce a high cash distribution akin to a dividend (16% over the past 12 months). SVOL tends to zigzag with the S&P 500, but with higher swings on the upside. It is “so far, so good” for this $247 million ETF, which just crossed its two-year anniversary May 12, and produced a cumulative total return of more than 14% versus the S&P 500 return of under 5%, while staying above or near its inception value throughout the period. 

Measuring the cumulative returns of those other ETFs over that same two-year period provides an indication of how wide a range of returns is possible when volatility is used as the asset itself. VIXM fell 29%, VIXY cratered by 81% despite several rallies of 30% or more and SVXY gained 55%, thanks to that brief period of panic in early 2022 giving way to a sustained period of declines in the VIX. 

Volatility ETFs are not for the faint of heart, nor are they a 1:1 substitute for equity ETFs. But when used prudently and in very small doses, they potentially offer a way to enhance returns, regardless of market direction.