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Volatility ETFs Slip as Fear Recedes

tlydon@globaltrend.com (Tom Lydon)

The CBOE Volatility Index or VIX has fallen below its long-term average of 20, signaling investors are growing more complacent about the ever-present Eurozone debt crisis. Volatility-linked exchange traded funds are also easing back but could see action as markets head into the third quarter of an election year.

The ProShares VIX Short-Term Futures ETF (VIXY - News) has plunged 27.3% over the last month and the ProShares VIX Mid-Term Futures ETF (VIXM - News) has dropped 10.9%.

The VIX now trades at about 17 after falling from 27 at the start of June.

Volatility traders may still get their chance as the third quarter of an election season marks the worst period for the S&P 500 ever since World War II.

However, ITG strategist Ralph Edwards cautions investors from becoming overzealous in betting on the upside of the VIX, reports Brenden Conway for Barron’s.

Specifically, Edwards pointed out that the iPath S&P 500 VIX Short-Term Futures ETN (VXX - News) , the largest VIX-related exchange traded note, call options to buy at $15 were rising Monday. VXX was trading at around $14 a share at last check. [Exchange traded notes.]

“If this represents a buy on the dips philosophy – hoping for a snapback uptick in volatility – that feeling may be misplaced,” Edwards said.

Assuming the Eurozone is moving on from its worst case scenario, “share count in the VXX could suffer going forward,” Edwards added. “The outstanding share count of VXX fluctuates much like option open interest, contingent on the demand for protection…  If this demand ebbs and share count contracts with declining fears about Europe, so will demand for the future’s contract roll.”

VIX contracts are used as a “fear” hedge against potential volatility down the road. With less macroeconomic risks in the future, demand for VIX futures will diminish. [VIX ETFs Thrive on Volatility and Risk Aversion]

VXX, the volatility ETN, is trading at a 52-week low. However, the VIX itself is above its one-year low. Why the difference? VXX tracks VIX futures, rather than the spot price. Therefore, the ETN can be hurt by “contango” in VIX futures. [Caveat Emptor -- Volatility ETFs]

For more information on market volatility, visit our volatility category.

Max Chen contributed to this article.