Alert

BIG TECH EARNINGS THIS WEEK! Find out what to expect.

Volatility Products: Analyzing Sensitivity

Apr 25, 2019

By: Sage Anderson

Although it may seem hard to believe, the VIX slid beneath 13 right before Tax Day in the USA, and closed April 14th trading at 12 and change. And just before Easter, it was threatening to close with an 11-handle.

So much for all that drama swirling around the "trade war," it would seem.

Simply stated, the VIX has gotten decimated since those dramatic days in November and December of last year when it seemed like the bottom might finally fall out of what has become the longest bull run in market history.

And while snow may have fallen not long ago in some parts of the USA, it's even starting to feel like the financial markets have already entered a sleepy, summer trading phase. Or at least it's being priced that way.

So what can we learn from the last several months of trading? If you haven't reviewed a previous episode focused on the recent pattern observed in VIX - "Cluster, Pop, Revert" - then we recommend doing so when your schedule allows.

To supplement those findings, the Market Measures team recently conducted new research on four different volatility products which evaluated their relative sensitivity to movement in the S&P 500. We think the findings will not only interest you, but possibly help you refine your approach going forward.

On the episode, historical data in VIX, VXXB, UVXY, and SVXY is analyzed with the intent of better understanding how each has reacted to movement (up or down) in the S&P 500 recently. Before jumping into the results, let’s first take a quick look at an overview of each one:

  • VIX: This is the famous (or infamous) CBOE Volatility Index which represents the market's expectation of 30-day forward-looking volatility based on the inputs of S&P 500 options. It is commonly believed to provide a measurement of market risk and investor sentiment.

  • VXXB: VXX was replaced by VXXB after VXX expired in 2018. The VXXB is an Exchange-Traded Note (ETN) that seeks to replicate the returns of a market benchmark - in this case that benchmark is the VIX. That means the VXX acts similar to the VIX, but not exactly the same. VXXB can be bought, sold, or sold short like a stock, which the VIX cannot. VXXB also has listed options. VXXB uses VIX futures to pursue its goal of replicating the return of the VIX. To make things a little confusing, the VXXB will change tickers and be renamed VXX in early May 2019 - but only the ticker will change.

  • UVXY: While the UVXY isn't the same as the VXXB, there are some similarities. As with the VXXB, the UVXY seeks to replicate the return of the VIX, but in this case its goal is 1.5x the VIX (the VXXB would be 1x the VIX). The fact that UVXY seeks a 1.5x return is a good indicator of its true self - a leveraged Exchange-Traded Fund (ETF). The method by which the UVXY achieves its 1.5x mandate is by purchasing extra VIX futures (as compared to VXXB) and also using margin (i.e. credit). As with any investment that involves credit, that dynamic means there are added complications when trading UVXY, and traders should research the product thoroughly before getting involved. The UVXY can be bought, sold, or sold short like a stock, and also has listed options.

  • SVXY: While the VXXB (an ETN) and UVXY (leveraged ETF) are designed to replicate the returns of the VIX (1x and 1.5x, respectively), the SVXY is what's known as an inverse ETF. In practice, that means the SVXY is intended to move in the opposite direction of the VIX - to the tune of -0.5x. Generally speaking, the SVXY should therefore increase when volatility falls, and decrease when volatility increases. Like VXXB and UVXY, the SVXY can be bought, sold, or sold short like a stock, and also has listed options.

The above information should serve only as an overview of these four volatility products. Prior to deploying a position in any of the above products, traders should conduct extensive research on the nature and behavior of them to ensure they match their outlook and risk profile - as with any potential investment product/strategy/structure.

Now that we've identified the four volatility products covered on Market Measures, we can return to the matter at hand - highlighting new tastytrade research on the relative sensitivity of these products to movement in the S&P 500.

The graph below highlights recent movement in each of the 4 volatility products over the last seven (or so) months. What's of particular interest over this span is the period when volatility picked up at the end of 2018. As highlighted in the large red square in the chart below, it's easy to see how each of the four responded to that particular pop in volatility:

Taking a quick look at the individual lines of data in the above graph, we can see that the behavior of movement in each product does match (to some degree) our expectation.

Due to frequency of selloffs in equities during this period, it's not surprising to see that the VIX launched higher - the options of the S&P were clearly pricing in a heightened risk environment.

What is a little surprising is the degree to which the VXXB and UVXY lagged the VIX, especially since they are intended to "replicate" its return (especially the UVXY which seeks 1.5x the return). However, an understanding of the mechanics of these products does help to explain the above behavior.

VXXB and UVXY use VIX futures to achieve their mandate, which means the products are constantly required to roll their positions into the new VIX futures month(s) when the old ones expire. As a result, this means the fund managers of those products are often forced to sell the lower priced VIX future, while simultaneously purchasing the higher-priced future VIX - because uncertainty is often priced "richer" the longer one goes out in time.

It's these realities (selling low and buying high) that produce the "drag" effect illustrated in the chart above, and help explain why VXXB and UVXY were more muted in response to the market chaos.

Looking at SVXY, we do see that it performed somewhat as expected - in the sense that it should move in the opposite direction of the VIX. And given it's target of -0.5x the VIX (i.e. reduced exposure) the less jagged behavior shown above makes sense.

Now that we have additional insight on how these four volatility products moved in the most recent VIX explosion, we can look a little more closely at their "average behavior," to see if any helpful information emerges. In order to produce the data for this examination, the Market Measures team utilized historical data in each going back to 2012.

The findings from this exercise were somewhat similar to what was observed in the graph shown above - and possibly match even more closely with our original expectations.

The first slide below summarizes how each of the 4 products moved on average during down days in the S&P 500 since 2012. The second slide provides a look at the same data on up days in the S&P 500 over the same time frame.

What's most telling in the "average" data shown above is how our expectation of the UVXY is confirmed in both slides. No matter whether it was an up or down day, the UVXY in both cases moved more "on average" than the VXXB - proving that it does indeed move to a greater degree with the VIX than the VXXB (the 1.5x mandate illustrated).

The last exercise on this episode of Market Measures was to analyze the pricing of the options in each of the four products to evaluate whether any attractive opportunities existed based on this data. While we think it's worth your time to review the complete episode focusing on "The Sensitivity of Volatility Products," a sneak peak of the results suggests that the options market somewhat efficiently prices the options of these products - meaning arbitrage between the four isn't *typically* attractive, and that the sensitivity of each is taken into account in the options markets.

If you want to learn more about the VIX, VXXB, UVXY, or SVXY, additional information can also be found using the search functionality on the tastytrade homepage.

Don’t hesitate to follow up with any feedback or questions on Twitter (@tastytrade) or email (support@tastytrade.com).


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.