New ETNs Allow You to Buy Volatility: VXX, VXZ

January 30, 2009 by  
Filed under Commentary, ETF IPOs (New ETFs), ETNs, Volatility Products

I feel fortunate that representatives from innovative mutual fund companies like Rydex, ProFunds, and Direxion have been visiting my office since they were startups. These regular visits provide insight to their product plans, and allow me a chance to suggest ideas for new funds.

Starting about a half-dozen years ago, I used every chance I could to request a mutual fund or ETF product based on the VIX, the volatility index. I ran some simulations showing how allocating a percentage of an equity portfolio to the VIX produced dramatic results, assuming you were able to rebalance your portfolio on a daily basis.

I’m not claiming that VIX-based funds were my idea, far from it. I’m sure I heard someone else say it first, but I have always thought they would be a great tool. I also learned a long time ago not to get too excited about new fund and ETF filings. For example, ProShares first filed with the SEC for leveraged and inverse funds in May 2002. It took more than four years for those products to gain approval and reach the market

So, when Direxion made an SEC filing for VIX based funds in July of 2007, I was hopeful, but I wasn’t holding my breath. Good thing, because they are still not available. Last August, Barclays filed for some VIX-based ETNs. This time the process didn’t take as long, and today they are here.

iPath S&P 500 VIX Short-Term Futures ETN (VXX): This exchange traded note is an unsecured debt security issued by Barclays Bank PLC designed to track the S&P 500 VIX Short-Term FuturesTM Index TR, which offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500® Index at various points along the volatility forward curve. Barclays has a VXX Overview on the iPath website.

iPath S&P 500 VIX Mid-Term Futures ETN (VXZ): This exchange traded note is an unsecured debt security issued by Barclays Bank PLC designed to track the S&P 500 VIX Mid-Term FuturesTM Index TR, which offers exposure to a daily rolling long position in the fourth, fifth, sixth, and seventh month VIX futures contracts and reflects the implied volatility of the S&P 500® Index at various points along the volatility forward curve. Barclays has a VXZ Overview on the iPath website.

Before using these ETNs in your trading, you should understand the following:

  • These products do not track the popular VIX index, they track VIX futures. VIX futures often act quite differently than the VIX spot market. The S&P white paper provides additional light on this subject, as does a recent article by Don Fishback.
  • These products are ETNs, not ETFs, please consult additional information on ETNs.

Unfortunately, someone will not heed the warnings, and we will see articles claiming that these products don’t work because they don’t track the VIX.

Despite the drawbacks, the ability to “buy” volatility with an exchange-traded product has been eagerly anticipated. I expect this to be one of the most successful new ETF/ETN product launches of 2009 and pull in a large amount of assets in a relatively short time. Both started trading this morning, and early indications are that traders prefer the VXX to VXZ. Nearly $15 million of VXX exchanged hands in the first three hours of trading today versus $5 million for VXZ.

Just make sure you know what you are buying before you place your trade.

Disclosure: No positions.

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