Shorting VXX


by Ian Harvey

Wednesday, October 12th, 2011

Shorting VXX Isn’t as Simple As It Seems!

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iPath S&P 500 VIX Short-Term Futures ETN (VXX) only emerged on the 29th January 2009. The period of time elapsed to obtain price history is limited to make sound investment judgments. However, below are some hypothetical historical prices, but before that, some facts about VXX. This is then followed by information regarding shorting VXX and the difficulties encountered.

Facts relating to iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX)

The S&P 500 VIX Short-Term Futures™ Index TR is designed to provide access to equity market volatility through CBOE Volatility Index® the “VIX Index” futures.

Specifically, the S&P 500 VIX Short-Term Futures™ Index TR 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.

The index futures roll continuously throughout each month from the first month VIX futures contract into the second month VIX futures contract.

A direct investment in VIX commonly referred to as spot VIX is not possible. The S&P 500 VIX Short-Term Futures™ Index TR holds VIX futures contracts, which could involve roll costs and exhibit different risk and return characteristics.

Investments offering volatility exposure can have various uses within a portfolio including hedging, directional, or arbitrage strategies and are typically short or medium-term in nature.

Hypothetical Prices for VXX

VXX proxies a 30-day, constant duration CBOE Market Volatility Index (VIX) future, therefore since futures started trading in 2004 by going back in time it is possible to calculate a hypothetical VXX. That's the blue part on the left of the graph. The red part in the middle is the VIX Short-Term Futures Index TR, which Barclays back-calculated when they created VXX. And finally, on the right in gray, we see actual VXX.

VXX estimates

Here's the actual VIX since then:


Well, pretty clearly, Virtual VXX would have taken a beating over time. From March 2004 to March 2007, it pared over 95% of its value. Meanwhile the VIX itself simply meandered within a low-level range. History repeated from pretty much the VXX launch in January 2009 to about two months ago. VIX, itself, did roughly halve in that stretch, though.

It is a well documented fact that the VXX loses money every day the nearest-month VIX futures trade in contango (i.e., second month higher than first month). VXX rolls out each day -- and if it rolls out higher, it loses a little money, which of course adds up in a big way over time.

Shorting VXX as a Trade

Shorting VXX is far from a simple trade. VIX futures don't always trade in contango (and, in fact, they're in modest backwardation at times). VIX does lift exponentially at times. And that combination literally tears apart VXX shorts. Walking in and shorting in summer or early fall 2008 would have seen it ramp up 400% against you. From summer trough to peak this year, VXX has lifted 250%, even though VIX itself hasn't seen nearly the pop it experienced in 2008.


There's one caveat though to analyzing a hypothetical VXX. Actually having VXX to trade affects the futures in a tail-wagging-dog sort of way. Volume in VXX has trended up over time, and exploded in times of big VIX moves. It's likely that VXX often moves the VIX futures, and not the other way around. And since shorting VXX as a dedicated strategy is way more prevalent than shorting VIX futures, it's not a leap to suggest that squeezed VXX shorts push the whole complex up in times of stress. In other words, if we could go back in our time machine to 2007 and list VXX, it would have probably popped further in the fall 2008 market meltdown.

VIX itself will ultimately mean revert, VIX futures will go back to contango, and VXX will begin another inexorable descent. But shorting VXX may bankrupt you first.

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