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 (see chart below).
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, rollsdown 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.
VXX outperforms the VIX!
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…
Hi, very interesting post, have you done any work on the backwardation duration and if it has any relation to the skew patterns?
i have found that the contango is highly correlated to the VIX itself, while skew is not as much. SKEW tends to cool off when we get backwardation (for the most part). And when we have high contango (like this April) the skew was also extreme.
Isn’t the relevant futures contract UX2 Index?