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American Capital Agency Corp. Message Board

  • raybans2 raybans2 Feb 23, 2014 11:01 AM Flag

    VXX price erosion explained

    It is clear to anyone who looks at a volatility ETF that there is a reliable price erosion that an investor can exploit. I found a web page that discussed this topic. The main topic of the article is how VXX ad VIX options differ and why one would be better of trading VXX instead.

    Here is a quote.

    "The VXX, and hence VXX options will be sensitive to the relationship between the current and next month futures prices on volatility. The VXX shifts its weighting between these two months on a daily basis. Generally this results in a price erosion force on the VXX relative to the VIX index because the further out month is usually higher in value than the close in month (called “contango” in futures parlance)"

    This explains the steady erosion and why it is so profitable to short them.

    Other quotes:

    "The implied volatility of the VXX options should generally be lower than the equivalent VIX options, because it is the mix of two months of volatility futures, not one like the VIX options. For example, for June expiration the volatility should be about the same the day after the May VIX options expire (because both sets of options are tied to June futures) , and the VXX option volatility should decrease relative to the VIX options as the time remaining on the June options decreases and the VXX picks up more weighting in the July volatility futures."

    "◦The VXX options quotes/option chains will be easier to find and their greeks will be correct. And everyone, including Schwab and Fidelity report incorrect greeks for VIX options– LIVEVOL being the only exception I am aware of."

    "◦The VXX options have American style exercise rather than the VIX option’s European style exercise. The European style exercise is necessary on the VIX options because the VIX options and VIX index are only guaranteed to be close once—at expiration time. The VXX and its options will naturally track each other well, so American exercise is ok."

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    • Even though this article was about VXX, the price erosion for TVIX and UVXY is much greater because they are leveraged where as VXX is not leveraged. This makes them a more reliable short with lower risk. That is why I call shorting TVIX free money.

      If you do not want to become part of the 1% then ignore this topic. Owning a dividend stock is a good way to sustain the value of your money against inflation with additional growth on top of that but you will not become wealthy with this approach so it can be safely said that you are protected from becoming part of the 1%. In this regard you will be safe in that you will live a mundane life free of the trappings of wealth.

      But then you can make a lot of money and never tell anyone and continue to live like you don't have money and your current friends will not feel intimidated by your wealth because they won't know you have it. You could be a covert 1 percenter and go around donating most of your money to thankless poor people so you can feel consistent about the ideological commitments you had before becoming wealthy. But there is a problem with this scenario which is that once you become wealthy you probably won't do this. It is more likelu that you will become a typical 1 percenter. So it is better that you stick to a slow growth approach that guarantees that you will not be tempted to be a typical 1 percenter. You know the story about getting a camel through the eye of a needle. It cannot be done.

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