Doug Kass

authored a piece on

iPath S&P 500 VIX ST Futures ETN


how bad of a product the Exchange-Traded Note is. He advised traders to say away from the product. My response would be that he is mostly right, and for the large majority of traders, the VXX is not the right product for their portfolio. That said, the VXX does exactly what its prospectus says it will do. Due to futures contango, in a low volatility environment, the VXX has what I call "the Sisyphus effect".

As days go by, VXX buys a future with somewhere between 60 and 30 days to expiration (give or take) it then rides that future down the curve for the next month, only to sell it out and buy another future. Buying something for $16 and selling it at $14 over and over again will have a strong negative effect on an Exchange-Traded Product. The chart that Doug pulled up clearly shows the long melt to zero for VXX. Sadly, some names like VelocityShares Daily 2x VIX ST ETN(TVIX) look even worse. But, in times of turmoil, when the futures curve flips into backwardation, VXX can actually have a positive carry. During these periods VXX will actually outperform the CBOE Volatility Index(VIX) future with a similar duration.

One long-term area where the VXX makes a ton of sense is actually on the short volatility side. If a trader has a portfolio that is short SPDR S&P 500 ETF (SPY) (like Doug said he currently is), or short a grouping of names, the trader's best friend is an increase in VIX. When VIX is rallying, generally SPY is dropping. In a case like this traders can use the Sisyphus effect to their advantage.

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One play that I might encourage Kass to look at is short SPY and short VXX as a pair trade. If SPY sits or creeps higher, he would likely make money (if he balances the weighting right). Then, when SPY finally starts dropping he could simply buy back VXX and let SPY run.

Let's hone in VXX chart, away from the long-term returns of VXX and looks only at the immediate short-term, one-to-two day timeframes, and the story changes dramatically. The intra-day movement of VXX does an excellent job of tracking the intra-day movements of VIX. Thus, if one thinks IV is going to go up in the immediate, buying VXX can be an excellent way to play increases. Additionally, as the VIX explodes higher VXX can be an excellent way to manage volatility risk.

VXX also has a much more standard settlement and weekly options.This allows the product to easily be used to play volatility in events that are going to occur in the extreme near term. Finally, the ETP often leads the SPY and ES futures before a move happens, I have found it to be an excellent directional trading indicator.

Basically, as a long-term buy and hold, VXX is doomed by its future carry risk, but in the immediate, the product can be used effectively to trade and manage volatility. It also has use in the event of a real stock market crisis.

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At the time of publication, Mark Sebastian held positions in VIX, VXX.