What is VXX?
The VXX is the largest and most liquid volatility ETN (electronically traded note) in the world. There is always a misconception that VXX and VIX are one and the same, but while they have a relationship, they are conceptually very different. The VIX is a ticker for the CBOE Volatility Index and is basically a measure of the market’s expectation of near-term volatility of the prices of S&P 500 stock index options. On the other hand, the VXX, a ticker for the iPath S&P 500 VIX Short Term Futures, is essentially a debt instrument designed to track the performance of a defined strategy, in this case, the total return of the S&P 500 VIX Short-Term Futures Index.
VXXB only began trading on January 30, 2009 and essentially allows investors to speculate on the VIX, and thus the degree of volatility in the US equities market. Generally, when volatility is expected to rise, investors will buy the VXX; and they will short the VXX when the expectation is that volatility will decline.
Like price and volume, volatility has been known to move the markets tremendously and, consequently, has a great impact on investor portfolios. Whether volatility is high or low, the VXX offers investors a unique opportunity to mitigate risk over time, as well as a chance to book massive trading profits.
How to Calculate the VXX?
VXXB is composed of a certain number of first-month and second-month VIX futures, and its value models the returns one would derive from holding the contracts throughout the periods, between expiration dates.
The arbitrary formula of calculating the price of VXX is as follows:
VXX = (p1*n1+p2*n2)/c
Where p1 and p2 represent the prices of the first and second-month VIX futures, and n1 and n2 denote the number of first and second-month futures contracts. N1 and n2 are chosen so as to have a 1-month average future lifetime of the VXX. C is the contract base.
This formula makes the VXX very vulnerable to both contango and backwardation, as these two factors significantly impact the contract base. Contango (or upward sloping) is when the futures price is higher than the expected future spot prices, while backwardation is when the futures price is lower than the expected future spot price.
Because a futures price eventually converges to the expected future spot price, contango is less desirable for speculators, whereas backwardation is more appealing. The VXX is rebalanced daily, which can lead to price erosion. This, as well as the mentioned mean-reverting tendency, makes trading the VXX on the options or futures market inherently risky.
Why Trade the VXX as a CFD?
Trading VXX as a CFD (Contract for Difference) with a reputable broker comes with the following advantages:
- Various intuitive and powerful trading platforms available for desktop and mobile
- Access to a range of automated trading solutions to minimize trading risks and enhance potential profitability
- Full support for Trading robots advisors
- Ability to Short sell (potentially earn when the market price is dropping)
- No added trading costs or hidden fees
- Competitive spreads
- Lack of the decay associated with contango and backwardation
How to Efficiently Trade the VXX?
As a Volatility ETN, the VXX is inherently risky to trade. Its composition also makes it difficult to trade in traditional markets. While it trades like a normal cfd stock, it follows VIX futures and its structure is bond-like. It also decays, like options. Still, the VXX offers exposure to overall market ‘fear’ and ‘greed’, without the unnecessary burden of predicting market direction.
It has, however, shown a negative correlation to the S&P 500, usually rising when equities decline and vice versa. Historically, it has also proven to overshoot the moves in the equities market. This means that if, for instance, stocks make a 5% upward move, the VXX can be expected to overshoot this move and post even a 25% downward move. With this information, VXXB traders can ride volatile times in the market profitably.
The VXXB and S&P 500 are not perfectly negatively correlated. This naturally gives traders opportunities to effectively time market reversals with minimal risk. For instance, a rising VXX and a rising S&P 500 would imply a bearish divergence with more likelihood of falling equity prices. Similarly, a falling VXX and a falling S&P 500 would denote a bullish divergence with more likelihood of rising equity prices.
The nature of VXX makes it a great hedge for equity positions, but its price overshoots also open up money-spinning opportunities for short-term traders who are chasing the profit motive. Additionally, trading the VXX as a CFD further reduces market exposure and dramatically enhances the profit potential due to availability of leveraged trading.
Trading the VXX with AvaTrade Australia
If you want to trade the VXXB effectively, AvaTrade provides many advantages to boost trading success. These include:
- Award-winning, regulated forex broker
- Innovative trading platforms allowing you to trade on desktop and on mobile trading
- Direct access to a free demo trading account with $100,000 in virtual funds
- Competitive spreads
- Free expert technical and fundamental analyses available daily and weekly
- Risk management tools
- Free education center comprised of eBooks and video tutorials
- 24/5 multilingual customer support
Do you want to trade the VXX CFD with an award-winning broker?
Open your trading account at AvaTrade or try our risk-free demo account!
Please note: CFD trading involves substantial risk of loss and is not suitable for all investors.
S&P 500 VIX Short-Term Futures ETN FAQ
- Why should I trade the S&P 500 VIX Short-Term Futures ETN – Series B?
When you see sharp moves in U.S. markets and keep getting stopped out of your trades because of that volatility you could simply move to the side-lines to wait for things to calm down. Or you could try to profit from that volatility by trading the S&P 500 VIX Short-Term Futures ETN – Series B. This fund looks to profit from increased volatility in the S&P 500, and can be a good way to avoid getting whipsawed by the moves in individual stocks while still maintaining a position in the market.
- Is the S&P 500 VIX Short-Term Futures ETN – Series B the best fund for trading U.S. markets?
Because it doesn’t measure the performance of U.S. markets, but instead tracks the volatility of those markets, we would hesitate to ever say that the S&P 500 VIX Short-Term Futures ETN – Series B is the best fund for trading U.S. markets. It could well be the best fund for trading volatility, or the rate of change, in U.S. markets however. And that can be very useful during times of uncertainty, or during any political or financial events that rattle markets. When you see large moves in either direction for equity indices it’s time to turn to an instrument like the S&P 500 VIX Short-Term Futures ETN – Series B.
- What’s the best strategy for trading the S&P 500 VIX Short-Term Futures ETN – Series B?
One of the characteristics that is little understood with the S&P 500 VIX Short-Term Futures ETN – Series B is that it does not directly mirror the moves in the underlying VIX index. In fact, it is fairly poor at mirroring the spot VIX. That makes it unsuitable for trading short-term moves effectively. It is very good however as a hedging strategy over a longer time frame. It can also be used in conjunction with protective option positions to create less risk in a trader’s portfolio.