After a tranquil start to the year, stock market volatility picked up in April, with the S&P 500 falling more than 5% from its highs as worries about inflation and interest rates intensified.
The most famous gauge of U.S. stock market volatility, the Cboe Volatility Index—VIX for short—shot as high as 19, a significant jump from the sub-13 level it was trading at before the market’s pullback. It’s since fallen back to less than 15.
The VIX doesn't measure actual, realized volatility. It measures what is known as implied volatility, which is calculated based on the price of near-term S&P 500 Index options. In other words, the VIX measures the market's best expectation of volatility over the next 30 days.
The index has a tendency to revert to the mean. The long-term average for the gauge is 19.53, which, as of this writing, is 30% higher than the current level of the index.
Given the high likelihood that the VIX will jump from here at some point, you may be wondering whether there is some way to buy the index and profit from potential upswings.
VIX Futures Explained
Unfortunately, the VIX itself―also known as spot VIX―is not investable. No vehicle exists to buy or sell the gauge, because the underlying portfolio of options that the index measures is constantly changing. However, there are financial products closely tied to movements in the index.
VIX futures contracts allow traders to bet on what value the index will be at some date in the future. Cboe lists a number of weekly and monthly VIX futures contracts whose values fluctuate based on where traders believe the level of the VIX will be at the contract's expiration date.
The value of VIX futures tends to converge with spot VIX as a contract's expiration nears, but can deviate significantly from spot for contracts where expiration is far in the future.
For example, as of this writing on May 1, VIX futures that expire on May 8 were trading at 15.23, modestly above the spot level of 14.78. However, VIX futures that expire on Oct. 16 were trading around 20, significantly above current spot levels.
Chart1
Source: Bloomberg
When the spot VIX is low, VIX futures typically trade at a premium (also known as contango). When spot VIX is high, the futures tend to trade at a discount (also known as backwardation) as traders anticipate an eventual reversion to the mean.
VIX ETFs
VIX futures aren't the only way to get exposure to the volatility index. Like many financial assets, VIX futures have been packaged into ETF wrappers in various ways, making it easier for investors and speculators to bet on volatility.
On a day-to-day basis, the correlation between VXX and spot VIX is strong. They largely move in the same direction on any given day, but the magnitude of moves is usually larger for spot VIX than VXX.
Longer term, there's a big divergence in the performance of spot VIX and futures-tracking products like VXX. Because futures contracts expire, VXX has to roll its futures position into later-dated contracts each month. When the futures curve is in contango (as it has been most of the time historically), with each subsequent futures contract trading at a premium to the last, VXX can afford fewer and fewer contracts over time.
Also known as a "roll cost," this reduces returns significantly over the long term. For example, over the past five years, VXX is down a whopping 96.93% (that's not a typo).
For comparison, spot VIX is up 2.43% in that same time period, while the value of front-month VIX futures is down 0.16%.
Other Long VIX ETFs
VXX is one of a dozen exchange-traded volatility products on the market. There are others offering nearly the same exposure, like the $143 million ProShares VIX Short-Term Futures ETF (VIXY).
Unsurprisingly, their long-term performance has been abysmal, with losses of almost 100% for each product since inception.
There are other products that attempt to mitigate the poor performance of the aforementioned short-term VIX ETFs by holding midterm futures. The $37 million iPath S&P 500 VIX Mid-Term Futures ETN (VXZ), which holds futures with a weighted-average maturity of five months, takes that approach.
Holding futures in the middle of the futures curve has historically reduced roll costs. VXZ held onto gains in the period between 2018 and late-2023. But steep losses this year have dragged its returns into the red.
VXZ Performance Since 2018
VXZ
Source: Bloomberg
Shorting The VIX
Taking an altogether different tack are short VIX products. The $291 million ProShares Short VIX Short-Term Futures ETF (SVXY) and the $178 million VS Trust -1x Short VIX Futures ETF (SVIX) capitalize on the same futures curve dynamics that hurt their long-VIX counterparts.
SVXY and SVIX offer, respectively, -0.5x and -1x inverse exposure to VIX futures by shorting contracts that have an average of one month until expiration.
Such strategies tend to pay off during periods of stable or declining volatility, but they suffer when markets are in turmoil.
Over the past two years, SVXY and SVIX are up 132% and 280%, respectively. SVIX launched when the stock market was near bear market lows, so it hasn’t had to experience many setbacks.
On the other hand, SVXY has been around a long time—since 2011—so it’s had a much bumpier road to get to where it is.
In 2018, the ETF lost 83% of its value in a single day after the VIX doubled. The event was dubbed “Volmageddon” and is a cautionary tale about what could go wrong when shorting the VIX.
SVXY Performance Since Inception
SVX Chart
Source: Bloomberg
In order to guard against the potential for those catastrophic losses, SVXY reduced its inverse exposure to VIX futures from -1x to -0.5x.
Another, newer ETF, the $854 million Simplify Volatility Premium ETF (SVOL)—the largest VIX ETF currently on the market—tones down its exposure to the VIX even more, while purchasing options contracts to protect against big losses in an attempt to create a more sustainable strategy.
The actively-managed fund targets daily returns that are -0.2x to -0.3x the performance of VIX futures, making it much less volatile than either SVXY or SVIX.
Since inception in May 2021, SVOL is up 38% versus 176% and 139%, respectively, for SVIX and SVXY.
Using Volatility ETFs
VIX ETFs aren't for everyone. They're certainly good products for speculators who can stomach the huge swings in the underlying VIX futures. Both short and long VIX ETFs can be lucrative for anyone who can time the movements in the VIX accurately.
For long-term investors, the evidence is clear that long VIX ETFs like VXX aren't fit for a portfolio. The new versions of short VIX products, which have performed well over the past few years, may have a place in a portfolio as a small “alternatives” position for certain investors.
Finally, there's the option to use volatility ETFs as a hedge. For example, VXX could be used to hedge against a market downturn. If the market declined, VXX would spike, offsetting losses in a broad market equity portfolio.
Such a hedge would be expensive―VXX has an annual fee of 0.89%, and, as stated previously, tends to lose a lot of its value over time due to roll costs. A volatility hedge would have to be timed well to prove fruitful, and requires at least some degree of speculation on the part of the investor.