Should You Be Trading VXX?
Should You Be Trading VXX?
One of the primary themes I like to discuss on this site is volatility. After all, you shouldn’t be trading options if you don’t at least have a basic understanding of why volatility is important to the financial markets.
So why is volatility important?
In a nutshell, volatility is significant because it tends to reflect investor uneasiness over market conditions. Volatility goes up (and makes options more expensive) when investors get nervous. That’s because investors buy more options for protection when they’re worried.
This dynamic can be measured by looking at the VIX, the CBOE’s S&P 500 Volatility Index. The higher the VIX is, the more nervous investors are about the possibility of a big selloff in the markets.
It’s always a good idea to keep any eye on the VIX.
However, the VIX is not a tradable instrument. It’s simply an index. You can trade options and futures on VIX, but not the index itself.
That’s where VXX comes in.
The iPath S&P 500 VIX Short Term Futures ETN (VXX) is the most popular way for investors to trade volatility. I’ve written about the VXX before, which you can see here.
Or you can check out the VXX main product page here if you want to read over the prospectus and such.
VXX tracks the first and second month futures for the VIX using a daily rolling position. That is, the index starts a given period as a roughly equal mix between the first and second month. As the first month future approaches expiration, the weighting shifts more and more to the second month.
Front month VIX futures are important because they reflect the current mood of investors. They are also the most heavily traded. But of course, an exchange traded product like VXX is much easier to trade than futures.
That’s precisely why the average volume of VXX is typically between 40 and 50 million contracts per day!
So should you also trade VXX?
If you trade volatility, either for speculation or hedging, it’s a good idea to at least pay attention to VXX. It’s a good measure of investor sentiment, and can provide an excellent short-term hedge for your portfolio.
Because VIX futures tend to trade in contango (the back months are more expensive than front months), VXX does tend to go down over time. So, for hedging purposes, you should only buy VXX or VXX calls for a short period of time.
VXX puts or short VXX positions are the better long-term bet. That’s typically where speculation comes into play.
Here’s the chart of VXX:
As you can see, VXX does tend to revert to its 50-day moving average over time. That’s why shorting VXX or buying puts is a good long-term strategy when VXX is high. On the other hand, being long VXX, or buying calls, is a great hedge when you’re worried about a short-term spike of volatility/market selloff.
Trading VXX is not the same as trading the VIX. However, it’s probably the easiest way to trade volatility since the VIX itself isn’t tradable. If you trade options, it makes sense to understand the value of VXX and how to trade it.
Yours in Profit,
Gordon Lewis
Options Trading Research
Note: Gordon Lewis has been trading options for more than 15 years and he now writes and edits for Optionstradingresearch.com. You can sign up for the newsletter and get a free research report. We are your go-to source for top notch options trading research.
Category: Options Trading
