Since their launch in 2006, volatility-linked options, notes and funds based on the CBOE Volatility Index, or VIX, have generally been a losing bet for investors. The assortment of funds and notes, of which there are now nearly a dozen, have dropped in value, beset with expenses, roll yield (the steep cost of constantly buying new VIX futures as contracts mature), the churn of leverage and the fact that, as the products have become mainstream, volatility (read: fear) has steadily dropped.
Not including options, the first and most widely traded VIX product, iPath S&P 500 VIX Short-Term Futures ETN (VXX),
Fear entered the market again on Wednesday, when the Dow plunged 279 points, its biggest drop in nearly a year, on concerns over slowing economic growth. The tape was ugly: only ten stocks in the S&P 500 ended higher.
The VIX, which uses S&P 500 option prices to show the market's expectations for 30-day volatility, leapt higher by 18%, carrying the wide assortment of (long) VIX-related funds/notes with it. Barclays iPath VIX Short-Term was up 6.29%. VelocityShares Daily 2x Short-Term ETN (TVIX),
Exchange-traded-products have undergone a revolution since we first pointed out "the trouble with ETFs" nearly a decade ago. In the case of volatility products, investors now have pushbutton access to an entirely new asset class, negatively correlated with stocks, with entirely unique risk/return characteristics.
And while serious options traders writing straddles or managing a complex portfolio could benefit from these funds, I'm less convinced of their usefulness to everyday investors -- even with yesterday's dive and the potential for a more sustained correction in stocks.
Stocks can grind lower for years, but volatility tends to spike and then quickly disappear. For those brief moments of panic, funds like iPath Long Enhanced S&P 500 VIX Mid-Term Futures soar. Yet looking further out, they can quickly turn into a loss even if stocks do decline given high costs of ownership over time.
In addition, we know that insurance works because the payoff outstrips the modest premiums. But on a day in which the Dow dropped almost 300 points, a 12% rise in the most leveraged VIX product available doesn't appear to be a terribly lucrative return.
Regardless of whether a bear market or recession return, those holding VIX funds or notes waiting for "the big one" might ultimately find it never comes. While markets always will correct, the fact is they have a tendency not to crash or implode. There have been over 50,000 trading days since the NYSE was created back in the late 1700s but arguably only a handful of true meltdowns.
Investors buying VIX funds are hoping for an extremely expensive event that, even given yesterday's plunge, barely ever occurs. I don't like those odds.
Funds for Betting on Fear:
- iPath S&P 500 VIX Short-term Futures ETF (VXX)
- iPath S&P 500 VIX Mid-term Futures ETF (VXZ)
- iPath Long Enhanced S&P 500 VIX Mid-term Futures ETN (VZZ)
- VelocityShares Long VIX Short-term ETN (VIIX)
- VelocityShares Long VIX Mid-term ETN (VIIZ)
- VelocityShares Daily 2x VIX Mid-term ETN (TVIZ)
- VelocityShares Daily 2x Leveraged VIX Short-Term ETN (TVIX)
- C-Tracks Citi Volatility Index Total Return ETF (CVOL)
- Selected Funds/Notes that offer long exposure to stock option volatility (VIX)