The VIX And It's Not So Identical Twins (VXX And VXZ)

Time for a little schooling on something a few of you may have some interest in over the next year or two the two $VIX long ETN's VXX and VXZ. What are they? How do they work? What is the difference? They are not your standard SPY type of index designed to track the VIX tick for tick. They are very different futures oriented ETNs that don't track the VIX as closely as you would imagine.

The reason for this post is to educate you in hoping you do a little research into the price relationships before you purchase one of these. I was about to pull the trigger last week and thought I would slap together a chart and see what was up. Boy was I amazed with what I found.

First let me introduce you to the two ETN's and share some of the vitals.

iPath S&P 500 VIX Short-Term Futures™ Index VXX

The S&P 500 VIX Short-Term Futures™ Index TR is designed to provide access to equity market volatility through CBOE Volatility Index® (the "VIX Index") futures. Specifically, the S&P 500 VIX Short-Term Futures™ Index TR offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500® Index at various points along the volatility forward curve. The index futures roll continuously throughout each month from the first month VIX futures contract into the second month VIX futures contract.

Correlations (As of 08/31/2009)
S&P 500 Index -0.74
CBOE SPX Volatility Index 0.71
S&P 500 VIX Short-Term Futures™ Index TR 1.00
S&P 500 VIX Mid-Term Futures™ Index TR 0.90

Sources: S&P, BGI (12/05-12/08) based on monthly returns.
Index returns prior to 1/22/09 are hypothetical and are an illustration of how the index would have performed based on current methodology. This data does not reflect actual performance of the index.

iNAV (Indicative Value) - $51.93 - Close price $52.35

iPath S&P 500 VIX Mid-Term Futures™ Index VXZ

The S&P 500 VIX Mid-Term Futures™ Index TR is designed to provide access to equity market volatility through CBOE Volatility Index® (the "VIX Index") futures. Specifically, the S&P 500 VIX Mid-Term Futures™ Index TR offers exposure to a daily rolling long position in the fourth, fifth, sixth and seventh month VIX futures contracts and reflects the implied volatility of the S&P 500® Index at various points along the volatility forward curve. The Index futures roll continuously throughout each month from the fourth month VIX futures contract into the seventh month VIX futures contract.

Correlations (As of 08/31/2009)
S&P 500 Index -0.69
CBOE SPX Volatility Index 0.66
S&P 500 VIX Short-Term Futures™ Index TR 0.90
S&P 500 VIX Mid-Term Futures™ Index TR 1.00

Sources: S&P, BGI (12/05-12/08) based on monthly returns.
Index returns prior to 1/22/09 are hypothetical and are an illustration of how the index would have performed based on current methodology. This data does not reflect actual performance of the index.

iNAV (Indicative Value) - $86.90 - Close price $87.29

iNAV is defined HERE.

Performance Chart - $VIX, VXX and VXZ (Better viewed HERE)

I can't really define or describe why some of the MASSIVE variances in price exist as I have just begun following these two strange breeds other than it happens as a result of the futures traded relating to the index. I would like to think the bots trading the futures on these bad boys would get a GPS and tack it on the VIX (think Santa). Might help a little. Both ETNs at one time or another have had GLARING price divergences (both to the good and bad) of up to 25% from the underlying index. Now tell me how much that would suck if you know the market is falling and your corresponding VIX ETN is falling with it?

Thus these should be purchased with severe caution and care. They should be compared (my charts update real time and can be found using my chartbook in stockcharts) as to their relative position to the VIX before purchase. Their iNAV relationship should be reviewed as well.

Other than the price divergences the one thing that gets my attention on the chart is that they all meet at two points, the top and the bottom (in black circles). Here we find the happy family all gathering together for a special occasion, but after the party is over they will invariably go their separate ways.



$VIX weekly chart - (Better viewed HERE)

What can you expect from the VIX? Well, if it all goes according to plan, the down trend line gives way to a possible breakout. The ABC pattern for the fall from grace has completed. A nice triangle formed on the bottom and price divergence to SPX has happened since July. It appears that a game plan can be made using the fib targets for the triangle breakout, the upper resistance line and the fibs for the B to C fall since they all nicely come together around $39. This would make the P3ers pretty happy and might coincide with the move for the end of wave 1 of 3. REMEMBER - you can not just look at this chart and go plunk some funds down in one of these ETNs. It ain't that easy.



BE CAREFUL with these delectable little devils. They will bite you if you do not do your homework prior to purchase. These IMO are NOT RELIABLE performers and you can either get the timing right or wrong and you won't have a clue as to why. One thing is for sure, they have not really had a down market to perform in, so maybe on the way up they will work better. Apparently I am one of the few and the proud to take on a post on these bad boys. Hell, even the Barclays sites description sucks on describing their own product. Always use stops and do your homework when playing with these fireballs.

UPDATE: I would like to suggest that you read this link from Vix and More: Why VXX Is Not a Good Short-Term or Long-Term Play

Let me ask this - if you like this post please promote it with links scouring the web and blogosphere. I believe it is important. Thanks.

I am long VXX.

GL trading,

Shanky