The Syrian civil war. Any or all of these factors, and many others, can roil markets and cause an upsurge in volatility, which in turn can wreak havoc on an equities portfolio. The fund industry has responded by launching a range of tools that purport to hedge the risk of uncertainty. Trading in these ETPs ostensibly gives investors an opportunity to profit when the VIX spikes, thereby offsetting potential losses in other areas of a portfolio. Read More Slow trading day?
But there is a major drawback to these products that many investors might be missing. The most popular VIX ETPs are not suitable for buy-and-hold investors because they are virtually guaranteed to lose money over time. In fact, since VIX ETPs first came to market beginning in , they have chalked up aggregate losses in the billions of dollars. In the index was modified by the CBOE. Since its creation, the VIX has become a very popular measurement of market anxiety, spiking during times of geopolitical and economic uncertainty.
For example, the VIX spiked to The first generation of exchange-traded volatility products were launched in the U. These date back to and , respectively. For most investors futures are impractical and as a result the second-generation of volatility products, VIX ETPs, came on the scene three years later allowing wider access to the investing public. Read More Low market volatility—storm ahead?: In , VIX futures trading volume hit a record high for the fourth year in a row, at nearly 40 million contracts — a jump of 65 percent over Last year, average daily trading volume also set a fourth-straight annual record, an increase over 67 percent from But for investors looking to hold VIX ETPs for longer than a very short period, these investments have serious drawbacks.
First is the reality of widespread misunderstanding about current VIX products. Close, but no VIX. This leads to the second pitfall. Because these strategies demand daily rebalancing, they are subject to high management fees. Add other expenses such as futures commissions, and trading and licensing fees, and it's clear that investors can find themselves in a hole before they even start to consider their returns.
But, even in the absence of fees and expenses, the trading strategies these products follow are destined to lose money from the "contango trap. Read More Millionaires' top 5 investing mistakes. My research found that the price curve sloped upwards on nearly 80 percent of all trading days for futures with day maturities.
This erosion happens because the price of longer-dated futures contracts is almost always higher than the price of shorter-dated futures contracts.
VIX ETP managers, who base their products on trading these futures, must roll these futures contracts from one month to the next. But as they become more expensive a "negative roll" , investors are hit with losses each month the price curve stays in contango. To make matters worse, most VIX ETP investors cannot gauge the magnitude of the losses they will incur because they do not have access to real-time or end-of-day VIX futures prices.
Nor do they realize that the mechanistic trading in the ETP makes holders vulnerable to pre-positioning by professional traders relating to the rebalancing of the underlying assets. The price curve tends to be much flatter, and, thus, the losses due to the contango trap are considerably lower — or incurred at a much slower rate. They eliminate many of the expenses and negative roll problems of existing products, and put investors much closer to the VIX index itself.
In short, they're ETFs that do what they say they're going to do, providing investors with true spot exposure to the VIX index. Commentary by Robert Whaley, a professor at Vanderbilt University.
VIX gives insight on market's mood: Severe downside But for investors looking to hold VIX ETPs for longer than a very short period, these investments have serious drawbacks.
Read More Millionaires' top 5 investing mistakes My research found that the price curve sloped upwards on nearly 80 percent of all trading days for futures with day maturities. Download the latest Flash player and try again.More...