The Russell 2000 is down 17 percent in the past three months, leaving traders with few winning options on the long side. However, one major theme that has been working like a charm is volatility. The iPath S&P 500 VIX Short-Term Futures ETN (VXX) is up 38.3 percent in the past three months, but Barclays is shutting down the fund in January.
Here’s a look at why the most popular volatility fund is getting scrapped, and where volatility investors can turn for alternatives after January.
What Is The VXX?
The VXX is a volatility exchange-traded note. Unlike exchange-traded funds, which buy and hold securities like stocks, ETNs are unsecured debt notes issued by financial institutions. In that sense, the VXX and other ETNs are more similar to corporate bonds than stocks, as their value is dependent on the credit-worthiness of the issuing bank. In the case of VXX, that’s Barclays.
The VXX provides exposure to short-term VIX futures contracts. It does this by tracking the S&P 500 VIX Short-Term Futures Index, which itself utilizes prices of the next two near-term VIX futures contracts to create what is essentially a continuously rolling long position in first and second-month VIX futures contracts.
What Is Happening to the VXX?
There are plenty of volatility funds, but the VXX is by far the most popular, averaging more than 50 million shares of daily trading volume. Due to the bond-like nature of ETNs like the VXX, these funds actually have maturity dates. Banks typically set these maturity dates for 20 or 30 years after the fund’s creation, and the VXX has a final redemption date of January 30, 2019.
At that point, all VXX shares will be redeemed for the indicative value of the fund at the time minus fees, and the ETN will no longer trade.
Just because the VXX and its cousin, the iPath S&P VIX Mid-Term Futures ETN (VXZ), will be maturing in January doesn’t mean volatility traders will be left out to dry. Barclays has already launched its replacements for the two ETFs: the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXXB) and the iPath Series B S&P 500 VIX Mid-Term Futures ETN (VXZB). In essence, the only change that will happen on January 30 for volatility traders is that they must add a “B” to the end of the two familiar volatility tickers when they trade.
Outside of the two iShares funds, other popular volatility funds include the ProShares VIX Short-Term Futures ETF (VIXY) and the VelocityShares Daily Long VIX Short-Term ETN (VIIX).
A Word of Caution
As we mentioned, volatility ETNs can be incredibly popular trading instruments. But there are serious risks involved which can quickly result in significant losses. The fact that these instruments are essentially derivatives of derivatives can cause extreme volatility. That’s what happened in February 2018, when a sudden spike in volatility destroyed two inverse volatility products, the VelocityShares Daily Inverse VIX Short-Term ETN (XIV) and ProShares Short VIX Short-Term Futures ETF (SVXY), overnight.
As with anything investment, it’s important to understand how these actually function before buying them.
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Disclosure: the author holds no position in the funds mentioned.
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