The one constant in the stock markets is change. Otherwise put, volatility is a constant companion to investors, which is why the Cboe Volatility Index (VIX) is such a widely tracked market index. Ever since this measurement of investor sentiment regarding future volatility was introduced (with futures and options following later), many investors have wondered about the best ways to trade the VIX Index.
Realizing the generally negative correlation between volatility and stock market performance, many investors have looked to use volatility instruments to hedge their portfolios. In this article, we'll review four ways you can trade the VIX using specific exchange-traded funds and exchange-traded notes through online brokers.
Key Takeaways
- Since the Cboe Volatility Index (VIX) was introduced, investors have traded this measure of investor sentiment about future volatility.
- The primary way to trade the VIX is to buy exchange-traded funds (ETFs) and exchange-traded notes (ETNs) tied to the VIX itself.
- ETFs and ETNs related to the VIX include the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) and the ProShares Short VIX Short-Term Futures ETF (SVXY).
Start With Understanding the VIX
Before trading exchange-traded funds (ETFs) and exchange-traded notes (ETNs) tied to the VIX itself, it's important to have a clear understanding of what the VIX really represents. VIX is the ticker symbol that refers to the Cboe Volatility Index. While often presented as an indicator of stock market volatility (and sometimes called the "Fear Index"), that is not entirely accurate.
VIX is a weighted mix of the prices for a blend of S&P 500 index options, from which implied volatility is derived. VIX really measures how much people are willing to pay to buy or sell the S&P 500, with the more they are willing to pay suggesting more uncertainty.
This is not the Black Scholes model—VIX is all about "implied" volatility and measures the market's expectations for volatility over the coming 30 days. What's more, while VIX is most often talked about on a spot basis, none of the ETFs or ETNs out there represent spot VIX volatility. Instead, they are collections of futures on the VIX that only roughly approximate the performance of the VIX.
A Host of Choices
The iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX)
While investors will often refer to VIX ETFs, the fact is that the majority of the investments offered are exchange-traded notes (ETNs). One of the largest and most successful VIX products is the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX). The VXX is issued by Barclays Capital and has an expense ratio of 0.89% and more than $450 million in assets under management (AUM) as of July 21, 2023.
The ETN formerly traded as the iPath S&P 500 VIX Short-Term Futures ETN (VXX) from its inception date of Jan. 29, 2009, until its maturity date of Jan. 30, 2019. Previously, VXX had a 10-year maturity, whereas the series B is a 30-year ETN and matures on Jan. 23, 2048.
This ETN holds a long position in first and second-month VIX futures contracts that roll daily. Because there is an insurance premium in longer-dated contracts, the VXX experiences a negative roll yield (basically, that means long-term holders will see a penalty to returns).
As a result, the performance of the VXX is stronger in the short term but not in the long term. Below are the investment returns based on various time periods as of June 30, 2023.
- One month: -27.70%
- Three months: -44.55%
- One year: -72.23%
- Three years: -64.26%
Because volatility is a mean-reverting phenomenon, VXX often trades higher than it otherwise should during periods of low present volatility (pricing in an expectation of increased volatility) and lower during periods of high present volatility (pricing a return to lower volatility).
The iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ)
The iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZ) is structurally similar to the VXX, but it holds positions in fourth-, fifth-, sixth-, and seventh-month VIX futures.
Accordingly, this is much more a measure of future volatility, and it tends to be a much less volatile play on volatility. This ETN typically has an average duration of around five months, and that same negative roll yield applies—if the market is stable and volatility is low, the futures index will lose money.
VXZ has an expense ratio of 0.89% and more than $47 million in assets under management (AUM) as of July 21, 2023.
Similar to VXX, the returns for VXZ are better in the short term versus the long term. Below are the performance returns based on available time periods as of June 30, 2023.
- One month: -18.04%
- Three months: -23.25%
- One year: -41.11%
- Three years: -19.54%
The ETN formerly traded as the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) and had a maturity date of Jan. 30, 2019. The inception date for the series B 30-year ETN was Jan. 17, 2018, and the maturity date is Jan. 23, 2048.
The ProShares VIX Mid-Term Futures ETF (VIXM)
The ProShares VIX Mid-Term Futures ETF (VIXM) VIXM tracks the S&P 500 VIX Mid-Term Futures Index, which measures the portfolio returns of VIX futures contracts that have a weighted average of five months to expiration. VIXM uses Cboe VIX futures contracts to help investors earn a profit from an increase in expected volatility in the S&P 500 index.
The VIXM has an expense ratio of 0.85% and more than $49 million in assets under management (AUM) as of July 21, 2023.
Below are the performance returns of the VIXM based on available time periods as of June 30, 2023.
- One month: -18.01%
- Three months: -23.64%
- One year: -42.11%
- Three years: -20.16%
The VIXM holds relatively longer-dated futures contracts and doesn't track the CBOE VIX. As a result, the fund can perform differently from the VIX. The VIXM is designed for knowledgeable investors with a short-term investment goal or who may want to hedge their equity exposure.
The ProShares Short VIX Short-Term Futures ETF (SVXY)
There is also an ETF for investors looking to play the other side of the volatility coin. The ProShares Short VIX Short-Term Futures ETF (SVXY) is an inverse ETF that seeks daily investment results equal to one-half the inverse of the daily performance of the S&P 500 VIX Short-Term Futures Index.
The SVXY has a slightly higher expense ratio of 0.95% and more than $293 million in assets under management (AUM) as of July 21, 2023.
A critical key for investing in SVXY is understanding that the fund is only intended for short-term trading and is not a buy-and-hold strategy. SVXY seeks its inverse return from its underlying benchmark for a single day, as measured from one net asset value (NAV) calculation to the next. Investors in SVXY should monitor and manage their investments daily. Inverse ETFs held for more than a day can lead to significant losses.
Below are the performance returns of the SVXY based on available time periods as of June 30, 2023.
- One month: 17.33%
- Three months: 32.83%
- One year: 75.65%
- Three years: 39.05%
Because inverse ETFs can rack up significant losses quickly, they are designed for knowledgeable investors who should carefully consider their risk tolerance before investing.
Beware the Lag
Investors considering these ETFs and ETNs should realize that they are not great proxies for the performance of the spot VIX. These funds can be expected to perform very differently from the VIX. Some may rise or fall in tandem with the VIX, but the rate at which they move and the lag time can make pinpointing entry and exit points challenging even for seasoned traders.
Market volatility investments are best suited for investors with a short-time horizon who can closely watch their positions and move quickly if the market turns against them.
If investors want to place bets on equity market volatility or use them as hedges, the VIX-related ETF and ETN products are acceptable but highly-flawed instruments; however, they certainly have a strong convenience aspect to them, as they trade like any other stock.
What Is the VIX?
The Cboe Volatility Index (VIX) representsthe market’s expectations for the strength of short-term price changes (or volatility) in the S&P 500 index (SPX). The level of market volatility is used to gauge market sentiment and the level of fear and uncertainty among market participants.
How to Trade the VIX?
The VIX, which is a measurement of volatility, can be traded through exchange-traded funds and notes that track volatility with the goal of earning short-term gains or hedging equity market volatility.
When Does VIX Trading Begin and End?
Investors can trade the VIX options and VIX ETFs during regular U.S. trading hours of 9:30 a.m. to 4:15 p.m. Eastern time.
The Bottom Line
Volatility is a measure of dispersion seen in financial instruments. Volatility is represented by the CBOE Volatility Index (VIX) and investors have sought ways to trade this index, primarily as a means to hedge their portfolios. For investors, choosing exchange-traded notes (ETNs) and exchange-traded funds (ETFs) as investment vehicles for this purpose are easily accessible options with plenty to choose from.
