In the first segment of this 3-part blog series, we detailed how options are not only tradable securities but also indicators of market sentiment. In Part 2 we introduced the VIX, or CBOE Volatility Index, which is one of the most popular products conceived and traded in the “pure” volatility sector.
Today, we’re expanding on the topic by introducing several other frequently traded products in the volatility space.
As a reminder, the price of an option fluctuates not only due to movement in the underlying security, but also due to the market’s anticipation of future movement - this is the volatility component of an option’s price.
While the VIX may be the most widely reported metric for tracking daily changes in volatility, there are many other such products that traders can follow and trade. Please also keep in mind that the underlying VIX Index frequently reported in financial media is not tradable, but /VX futures and VIX options are.
The next most cited volatility measurement/product after the VIX is arguably the VXX, which is an Exchange-Traded Note (ETN). Exchange Traded Notes and Exchange-Traded Funds (ETFs) act much like listed stocks on an exchange. ETNs such as VXX are designed to provide investors with the return of a market benchmark.
The benchmark that VXX tracks is the S&P 500 VIX Short-Term Futures Total Return Index, which in itself is a 30-day estimator of VIX futures. Because the VXX is an ETN, fund administrators adjust the security on a daily basis by selling front month VIX futures and buying second VIX month futures. That means the VXX is concentrated on short-term changes in volatility, due to its focus on the first two months of /VX futures.
The need for the VXX to trade in and out of the front two positions also means that it won’t mimic the performance of VIX futures identically - an effect that is referred to as “drag.”
Because VIX futures work in contango and backwardation, this means the VXX will underperform the VIX index most of the time (~70%, during contango), and outperform the VIX at other times (~30%, during backwardation). One can visualize this “drag” phenomenon by imagining VXX administrators selling the cheaper front month VIX futures and buying the more expensive second month VIX futures during contango.
The net result is that while the VIX and VXX are highly correlated, the total returns of the two will vary (at times significantly).
If your head isn’t already swimming, consider the fact that VXX also offers listed options. For more information on VXX options we recommend you watch this episode of Calling All Millionaires.
Moving on to another related volatility measurement/product, we find the UVXY.
Think of the UVXY as a super-charged VXX as its purpose is to replicate twice (2x) the daily percentage change of the S&P 500 VIX Short-Term Futures Index. The UVXY will also experience the “drag” effect found in the VXX as it relates to contango and backwardation. Options are available on the UVXY, although the liquidity is somewhat lower as compared to VIX and VXX.
A good way to gain a better understanding of the relationship between VIX, VXX, and UVXY is by watching how the three move in comparison to each other across a variety of market conditions.
Further information on all three products is also available through the search functionality on the tastytrade website.
Please don’t hesitate to reach out with any questions or comments on volatility measurements/products at email@example.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.