Opportunity in Volatility – Trading VXX

As traders and students of the markets, we are obligated to adapt to changes in market conditions and recognize opportunities when they present themselves in order to profit. With recent changes in the market place, there has been an influx of tools that are introduced to the speculators and investors alike by financial institutions in order to cater to their risk appetites and objectives. One of the most traded ETFs introduced to the market for speculators with higher risk appetite is VXX (iPath S&P 500 VIX Short-Term Futures).

The objective of VXX is to duplicate the S&P500 VIX short term futures Index.

(minus ETF expenses). One of the biggest misconceptions that most traders have is comparing the price fluctuations of the actual $VIX, whose goal is to estimate the implied volatility of S&P 500 index over the next 30 days with VXX.  Although they both measure fluctuations in volatility, the difference in their time frame measures makes them very different from each other. There is not an instrument available in the market place that can duplicate the actual $VIX price action.  Since VXX only measures the short term volatility, its fluctuations in the market are more skewed and directional to the downside. The weekly chart below clearly shows the price behavior of this ETN since its inception. With this thesis in mind, we decided to put this theory to work.

On August 20th, 2013 we decided to purchase VXX December 60 Puts (post split price). We exited this position on Dec 5th with a 47% profit. The idea behind buying 4 months out expiry was to be able to ride the volatility without taking too much risk in price action.  Time would work against VXX due to its decay factor without theta eating too much into our premium.  Although there were times that there was an increase in volatility, the momentum of downside pressure has continually worked much faster than the upside spikes in price of VXX.

The bottom line is that VXX is simply a trading tool for very short term (a few days at the most) with very high decay factor during periods of relative calm in the markets. The best way to trade VXX is to simply bet against it during periods of relatively higher volatility in the markets.

Pirouz Hendi of Hamzei Analytics