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'Fear Index' ETF Goes on a Wild Ride

Stocks in this article: VXXVXZ

The VIX exchange traded notes from iPath have experienced wild trading and intense emotions in the marketplace.

The funds are the iPath S&P 500 VIX Short Term Futures ETN (VXX), which targets one- and two-month futures, and the VIX Medium Term Futures ETN (VXZ), which focus on futures expiring in four to seven months. VIX, the CBOE Volatility Index, is a measure of market expectations using the S&P 500 Index.

There seemed to have been two uses, or potential uses, when the funds were first listed. One was to speculate on the movement of the VIX index and the other as a potential hedge for a portfolio. An unknown factor at the start was how these might trade in the real world. The nature of the futures contracts is that they represent the market's perception of where the VIX index will be at expiration. This means that, potentially, the ETNs can diverge from the underlying index. It also means that the Short Term Futures ETN should track closer to the underlying index than the Medium Term Futures ETN -- most of the time, anyway. "Most of the time" is key here because there are very few absolutes. Any decision to use these for either purpose must consider that fact.

The VIX index is often referred to as the "fear index," with the thinking being that VIX goes up when the market goes down. This may be true as a generalization but not as an absolute. Again, there are very few absolutes.

Portfolio hedging has been a popular topic as the bear market has worn on with investors trying to find a hedging device that won't surprise them and an ETF industry seemingly intent on creating more solutions all the time. ProShares and Rydex have inverse and two-times inverse funds, Direxion has three-times inverse funds and IndexIQ has listed two ETFs that purport to provide hedge-fund strategies to individual investors. The latest is a filing from a company called FactorETF that plans to launch funds that will pit various asset classes and stock-market segments against each other to capture relative outperformance or underperformance. This space will only get larger.

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