I read this news yesterday that options are being added for more volatility products; the new additions are for VXN (Nasdaq 100) and RVX (Russell 2000).Every so often someone will leave a comment wishing for a VIX ETF. On the surface there seems to be some appeal, but as Adam Warner notes there are a lot of potential flaws with such a product.
We saw with the USO Oil product that not every ETF will work and something as complicated as an ETF to mimic VIX seems like one with a high likelihood to misfire but if it did work I might have an idea of how it could applied in a diversified portfolio, its special purpose so to speak.
I would imagine that this would be one of those funds that was 95% t-bills and 5% futures. In eyeballing any SPX/VIX comparison chart the two appear to have a very low correlation; PortfolioScience puts the three month number at -0.889 so almost a perfect negative correlation.
So is there room in a diversified portfolio for something with a negative correlation to stocks that yields 4-5%? Your answer to that question will determine your level of interest.
A notion I have touched on before is that if the US stock market is evolving to have more volatility and slightly lower returns then having a few different things with some yield that have little to do with the stock market (along with some foreign stocks, currencies and commodities) will make sense.
I would expect that most of the time it would bounce around pretty aggressively within various ranges and during times of panic, like we had this summer, it would go up a lot. I think that anytime it did panic higher it would need to be sold and then it would take patience before buying again.
There is a lot of fear that things are somehow going to be different. While I think that is unlikely, if things are going to be different something like a VIX ETF, should it ever come, could be a good fit in this context.
7 comments:
I've been one of those who would like to buy/sell the VIX directly, via ETF or similar. There are options (puts/calls) on VIX but they don't perform like options on stocks, I think because there's a vega-squared term. Also, bid/ask spread is large, so inefficient. I suspect the VIX instrument doesn't exist today because it would be difficult for arbs to efficiently hedge the underlying variable - and unfortunately I don't really see a solution.
Michael
I had heard the reason it too so long for options to trade on VIX was a lack of an efficient hedge.
"I suspect the VIX instrument doesn't exist today because it would be difficult for arbs to efficiently hedge the underlying variable."
On any ETF, how that is done is curious. Anybody have a simple explanation of the arbitration process/mechanism? That is, how does the process try to insure accurate correlation with the underlying stocks?
This is the key to my comment above. Two forces are at work on the ETF. One is the market fluctuation of the ETF itself. The other is the market fluctuation of the underlying stock. This would seem highly tricky to correlate.John
Based on the option traders I talk to from time to time, the VIX options have some nuances. For example, there are cases where the front month is worth more than months further out. This was explained to me why, but I've forgotten (or didn't understand fully) and have currently chalked up VIX options to something I don't understand and as a result, won't trade for now. This may not be applicable to the tracking ETF, but it seems to me like it could exacerbate the tracking error that is highly likely leaving people confused and frustrated. Like Adam, at this point in time, I like to trade volatility using plain options themselves. The negative correlation is nice, but why not just use an inverse ETF which is straightforward.
My rather uninformed opinion at this point is that this probably isn't a tool for the average individual in a long term portfolio.
the front months being more expensive has to do with the manner in which the market looks forward to volatiltiy. essentially short term vol is always greater than long term vol.
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