This past week on RealMoney, Don Dion blogged about ETNs designed to track the VIX, Eastern Europe ETFs and Brazil.
VIX-Based ETN Correlations Are Skewed
Posted 10/5/2009 5:20 p.m. EDT
iPath S&P 500 VIX Short-Term Futures Index ETN
iPath S&P 500 VIX Mid-Term Futures Index ETN
didn't capture as much of last week's pop in the CBOE Volatility Index (a.k.a., VIX) as some traders may have liked.
Between Tuesday and Friday, the VIX gained nearly 20%, but VXX only gained about 8%, while VXZ managed just 4%. On the flip-side, today's loss cost the VIX nearly 7%, but VXX shed 4% and VXZ fell less than 2%.
One difficulty with the rolling futures contract is that the future never arrives.
Options and futures have two components to their value:
- the underlying value of the security or index; and
- the time value.
For example, if you have the option to buy a stock one year from now, there is a greater probability that the stock will rise or fall a given amount over the course of a year, as opposed to one week.
If you purchase a futures contract and hold it until just before expiration, the time value will decay to nothing, and you will be left with the underlying value. Since these contracts roll daily, however, the time value is constantly replenished. A change in time value can affect the NAV of these ETNs, but it will never be replaced by the underlying value.
The VXZ holds futures contracts on the VIX in the fourth-, fifth-, sixth- and seventh-month contract, dropping the fourth- and rolling into the new seventh-month contract each day.
The VXZ will never be as volatile as the VXX, since the VXX holds first- and second-month contracts, also using a daily roll strategy.