This article was originally published on ETFTrends.com.
The extended bouts of volatility this year has been a boon for volatility-related exchange traded funds as the CBOE Volatility Index, or so-called VIX, remained elevated for much of the year.
The CBOE Volatility index was trading around a 30.1 reading Wednesday and hovered around its historical average of a 20 reading ever since the markets tanked at the start of October. In comparison, the VIX traded below the 10 level at the end of 2018, marking 2017 as one of the least volatile years in decades.
Meanwhile, the iPath S&P 500 VIX Short-Term Futures ETN (VXX), the largest VIX-related exchange traded product, gained 76.8% year-to-date, surging 83.3% over the past three months.
The frequent bouts of market oscillations have kept traders on their toes in the volatility segment and made betting on the market’s misfortune a profitable play.
“The thing that worked in the volatility space this year is the thing that almost never works - just buy and hold volatility,” Matt Thompson, co-head of commodity trading adviser Typhon Capital Plc’s volatility group, told Reuters.
Volatility typically rises when stocks pullback, so owning volatility is seen as a type of market insurance. However, the play comes with a cost.
“Usually it costs a lot to own volatility,” Jim Carney, chief executive officer at hedge fund Parplus Partners, told Reuters.
Volatility- or VIX-related ETPs typically track the futures market, so they can lose value quickly during calm or bullish market conditions since VIX futures are almost always in a perpetual state of contango – a condition when later-dated contracts cost more than near-term contracts. Consequently, as VIX ETPs roll their contracts when the futures near expiry, the products are essentially buying later-dated contracts at a high and selling near-expiry contracts at a low.
“When the front month VIX future is below the second month there’s a huge cost to owning the product, but now with the front month around the same level of the second month, or above it, there is no cost,” Carney added.
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