This article was originally published on ETFTrends.com.
While the equity markets were slowly pushing forward, the CBOE Volatility Index and VIX-related exchange traded funds jumped, potentially reflecting an increase in demand to hedge against swings ahead after a smooth ride.
On Friday, the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX) increased 1.4%, ProShares VIX Short-Term Futures ETF (VIXY) advanced 1.5% and VelocityShares Daily Long VIX Short-Term ETN (VIIX) gained 1.0% while the CBOE Volatility Index, or the so-called VIX, jumped 4.6% to 13.2, touching its short-term resistance at the 50-day simple moving average. Potential investors should keep in mind that VIX-related exchange traded products track VIX futures and not the spot price.
Volatility typically rises when stocks pullback, so owning volatility is seen as a type of market insurance. The Volatility Index, or VIX, an instrument created by the Chicago Board Options Exchange (CBOE), is a real-time market index that represents the market’s expectation of a month period of forward-looking volatility. In most cases, the higher the volatility, the riskier the security.
Derived from the price inputs of the S&P 500 index options, the VIX provides a measure of market risk and investors’ sentiments. It is also known by other names like “Fear Gauge” or “Fear Index,” as investors, research analysts and portfolio managers generally look at VIX values as a way to measure market risk, fear and stress before they take investment decisions.
VIX ETP investors should also be aware of the potential drawbacks of owning these volatility futures-related strategies, especially over the long-run. 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.
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