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VXX Outperforms the VIX

There are numerous articles on the profitability in shorting the Ipath S&P 500 VIX Short-term Future Exchange traded note, A.K.A VXX.   Some investors who thought this was a fool-proof strategy will be scratching their heads about the stellar two month performance of VXX:


VXX outperforms the VIX!

The key performance reasons have been 1) rising levels in all of the VIX futures contracts and 2) the movement from contango to backwardation.

When the VIX futures curve is in contango, the VXX ETN continously buys a futures contract that ages, rolls down the curve, and loses value.  When the VIX futures curve is in backwardation the opposite process happens – the ETN buys a futures contract that ages, rolls up the curve, and gains value.

By looking at the last two month spread between the 4th month and 1 month VIX futures contract, we can see that there has been strong backwardation since the beginning of August:


Backwardation shown in the VIX futures spread between 1 month and 4 month

The good news if you are short: these periods of backwardation have always reverted to contango in the past and there is no reason that we should expect this time to be different.

Volatility cannot stay at 45% because there would be very few equity investors left to trade if daily moves were expected to be in the 3%+ range.  Even the black boxes need investors to backstop their losses…


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3 Responses

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  1. Actuary says

    So I’ve been following the first three months of the vix futures very closely, waiting intently for the backwardation to reverse. Would you start shorting VXX before seeing contango, with the assumption that the spot prices will bring the front part of the curve down despite backwardation (hence a profitable short), or would you think a better strategy is to wait for the futures to settle down to their normal pattern before shorting?

  2. SurlyTrader says

    One way to get short early and protect yourself against losses is to short VIX call spreads directly. You can sell deep in the money calls in the VIX options space and buy out of the money VIX calls at specific maturities that look attractive in the vix futures space. Likewise, you can place this trade directly with VXX by selling in the money call spreads.

Continuing the Discussion

  1. Wednesday links: buying and selling | Abnormal Returns linked to this post on October 5, 2011

    […] Why $VXX has been outperforming $VIX of late.  (SurlyTrader) […]

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