VXX: Why It Gets Some Interesting Reactions
TheStreet Premium Services
A complimentary preview
of Options Profits
WEBINAR: Stocks to Watch and Trade Ideas 12/18 at 6pm ET CLICK HERE FOR INVITE AND TO REGISTER
Mention iPath S&P 500 VIX ST Futures ETN (VXX) among active investors, and you're likely to get some interesting reactions. Investors who only trade stocks are sometimes surprised by the carrying costs of the ETF, which is essentially long a portfolio of SPX options on a rolling basis. You can even find traders in internet forums claiming that VXX is "broken," when what they probably mean is that the cost of being long SPX implied volatility is higher than they expected. (The ETF does exactly what it claims in the prospectus, for the record.)
A more sophisticated -- but just as mistaken -- worry is that the way VXX is constructed might cause it to have an unusual return distribution. But this is an empirical question: all we have to do is to look at the historical data.
The histogram at Fig. 1 shows the frequency of VXX daily returns at various percentage thresholds. For reference, I've plotted a normal distribution over the same range in dark blue. As you can see, VXX returns are not precisely normal; but they're also not wildly divergent.
As countless gurus and swan-mongers have pointed out over the last several years, equity returns have fatter tails than a normal distribution would indicate, and we see that in VXX as well. But that's also true of SPX, and at this point it's kind of passe to treat the existence of tail risk as news. The flip side of a leptokurtic distribution is that you see more observations around the mean, and that holds in this case pretty clearly. Finally, we can note the positive skewness in VXX returns: the mean is negative (-0.0042) and the tails are longer on the right side.
This confirms what most VXX buyers and options traders already know: buying volatility can generate low-probability, high-impact payoffs, but with a frequent and not insignificant carrying cost.
OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits
Jared can be followed on Twitter at twitter.com/CondorOptions
EXCLUSIVE OFFER: Jim Cramer's Protégé, Dave Peltier, only buys Stocks Under $10 that he thinks could potentially double. See what he's trading today with a 14-day FREE pass.