Is The Holy Grail Of VIX Investing Finally Here?

Today, May 3, 2016 two new volatility ETFs will start trading on the BATS electronic exchange – the REX VolMAXX Long VIX Weekly Futures Strategy ETF (VMAX) and the REX VolMAXX Inverse VIX Weekly Futures Strategy ETF (VMIN). Both will start with an NAV of $25 per share. These ETFs are the first products on the market that will provide exposure to the VIX Weekly Futures market which started trading on July 23 of 2015, roughly a year ago. I had a chance to sit down with the team that created these ETFs and discuss their goals and aspirations for these new products.

The issuer of these two new volatility ETFs is REX Shares, a new start-up ETF outfit headed by Greg King. Greg King, largely unknown to the retail volatility investor, has an impressive track record in the ETF industry. He headed the iPath ETN platform at Barclays where he came up with the concept of the Exchange Traded Note (ETN) and created the first volatility ETN in 2009 – the iPath S&P 500 VIX Short Term Futures ETN (VXX). Subsequently, he founded the ETF company VelocityShares, which was eventually acquired by Credit Suisse and which gave us the second and most popular volatility ETN in 2011 – the VelocityShares Daily Inverse VIX Short Term ETN (XIV). Today VXX and XIV are the 2 oldest and most popular volatility products and command a combined AUM of more than $2 billion on any given day. Greg King is a true visionary in the ETF world and we owe much of what we see on the ETF scene today to him. You can think of him as the Elon Musk of ETFs. 

Like a good movie producer, Mr. King wasn’t satisfied with his original VIX ETF creations and wanted to go bigger and better. The result of these efforts are these new VMAX and VMIN ETFs that are going to start trading today.

How Do VXX and XIV Fall Short?

Before we delve into VMIN and VMAX, let’s look first at the issues the REX Shares team is trying to fix in the current leaders in the volatility ETF world – XIV and VXX.

Beta and Correlation

A common criticism of VXX and XIV are that while they provide exposure to the VIX, they do so only in a half-baked manner. As I discussed in the SA article But Why? VXX and XIV Are Already Just Perfect, these ETNs are constrained by the products in which they invest. Since these ETNs are composed of monthly VIX Futures and monthly VIX Futures represent what investors think the VIX will be further out in time, they do not provide a perfect VIX exposure. The VXX and XIV essentially give you exposure to a synthetic VIX future with an average time to expiration (TTE) of 30 days (I will call this VIXFUT30 for the remainder of this article). The farther the average time to expiration, the more disconnected the ETF or the synthetic future will be from the VIX itself.

Source: volmaxx.com

As you can see in this graph, the 30 day TTE VIX Future would result in Beta of roughly 0.5. This is confirmed by my own observations. I calculated the Beta of XIV, VXX and the VIXFU30 against the VIX for the entire history of these products (starting in 2009 for VXX, 2011 for XIV and 2004 for the VIXFUT30) and those values came out to be -0.46, 0.46 and 0.46 respectively (the XIV being the inverse of the VIXFUT30 obviously).

What do these numbers mean?

A correlation means how often that does one product move with the other. How often does the VXX go up when the VIX goes up? Well, it turns out that is 88%. This is very good but not perfect. As VXX investors are well aware, there are many days when the VIX goes up but the VXX doesn’t.

A beta means how much of the move is captured. How much does the VXX go up when the VIX goes up? Well, it turns out the VXX goes 46 cents for every $1 that the VIX moves. So if the VIX moves 10%, on average the VXX goes up 4.6%. As most of volatility investors have observed, that has roughly been the case.

The Contango Effect

Another concern is that the XIV and VXX are heavily influenced by the Contango present in the front month VIX futures. The VX1-VX2 contango of which these ETFs are composed, has averaged 5.4% since 2004 and that has resulted in steady but consistent decline especially in the VXX. Most, even sophisticated, investors don’t understand the inner workings of the ETFs and are often surprised at how much money they lose in them since they think they are an exact VIX replacement. The VXX is -99.8% since its inception in 2009 while the XIV is +191.7%.

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Comments

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Bill Johnson 2 years ago Member's comment

Good stuff. Will we see more by you?

Joe Economy 4 years ago Member's comment

Frankly find the whole world of volatility ETFs somewhat confusing. In layman's terms how do these compare to regular stocks or Index funds? Do you have a link to send me that provides an broad overview of these types of investments? Thanks

Stephen Aniston 4 years ago Author's comment

https://vixcontango.com/site/introduction You might want to watch the video as well.