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Summary Volatility products can provide market leading returns. Proper education and knowledge of the VIX futures market is needed to be highly successful. Risk factors should be accounted for when creating and implementing your strategy. Welcome to the Seeking Alpha ETF Guide. This article will focus on how a VIX ETF could play an active role in your portfolio. When looking for a VIX ETF you have several different options between short-term and mid-term futures products. This article will cover only the most active funds. For more options visit the Seeking Alpha ETF Hub for a list of all volatility funds. Both types of products (short and mid-term) focus on the VIX Futures which trade independent of the market and the popular and well publicized VIX Index. Short-Term There are two types of short-term volatility products. To determine which type of product is for you, you first need to determine whether you are betting on an increase or decrease in volatility. Long volatility products, such as iPath S&P 500 VIX ST Futures ETN (NYSEARCA: VXX ) and ProShares Ultra VIX Short-Term Futures (NYSEARCA: UVXY ) which offers two times the leverage, benefit from increasing volatility. During periods of low or decreasing volatility, inverse products such as VelocityShares Daily Inverse VIX ST ETN (NASDAQ: XIV ) and ProShares Short VIX Short-Term Futures (NYSEARCA: SVXY ), produce better results. All short-term VIX products focus on the front and second month’s contract in the VIX Futures. Mid-Term You also have long and inverse options available in mid-term futures products. For rising mid-term futures you have VelocityShares Daily Inverse VIX MT ETN (NASDAQ: ZIV ) and for decreasing mid-term futures there is VelocityShares Daily Inverse VIX MT ETN . All mid-term VIX products focus on the seventh through fourth month’s contracts in the VIX futures. Mid-term futures products are not as popular as the short-term products. Education Investors looking to use VIX products in their portfolios should have a very high level of education into the inner workings of the VIX Futures market. Seeking Alpha is a great resource for many articles that focus on the how and why rather than the right now. I have written many articles that are specifically geared towards investor education and are meant to serve as training tools for years to come. Since the vast majority of these products have been around less than a decade, back testing is often used to demonstrate the effectiveness of different strategies. Investors should also note there are distinct differences between short-term and mid-term volatility products. A personal pet peeve for me is when I see comments such as “this thing is rigged.” That is a good example of someone who hasn’t educated themselves on volatility and is now mad about their poor decision. Many misconceptions exist in regards to VIX Futures products. A thorough understanding of how these products are structured can prevent expensive mistakes. Trades based on hopes and dreams or borrowed money are a recipe for disaster. A proper education is the only way to prevent failure when trading volatility. Contango/Backwardation A key indicator when determining longer-term directions of volatility products are contango and backwardation. Contango will benefit inverse volatility products, like XIV, while backwardation will benefit long volatility products, such as VXX. For more information on this key metric I recommend this short video . Trading Objectives Long volatility products – Many investors use long volatility products as insurance for their primary portfolio. It is difficult to time spikes in the VIX and these products lose value over time. They are not meant to be buy and hold investments. From historical data, the longest these products have gone without losing value is less than one year. Inverse volatility products – During flat and rising markets, these products can often beat the major benchmark indices. Although I don’t advocate a long-term buy and hold strategy with any volatility products, short-term inverse funds have provided the best returns when held for periods of 2-6 months. Risks This would be the most important section of this article. I have spent countless hours promoting the education and risk factors of investing in various VIX funds. Although these products can provide returns several times greater than the market, they also come with many risks that are hidden to novice investors. I have seen many beginners with high hopes of getting rich quick. They may win the first or second hand but eventually lose all or a very significant amount of their capital by not properly assessing risks before making trades. If you do not fully understand how these products work or do not have a thorough idea of the risks of investing in volatility, my recommendation would be to avoid them while you become more comfortable and complete additional research. Practice accounts and small trades are a great way to build real knowledge on the effectiveness of your strategy. Rising markets make inverse products seem like the perfect investments. However, these products can easily lose 50-80% of their value during periods of economic turmoil. Black swan events are rare but would significantly effect volatility products. Historical examples of these events would include acts of war, terrorism, and other unforeseen events that would have profound impacts on the market. Returns VIX funds have provided some of the best returns over short to medium time frames. Take a look below at some of the best results for inverse and long volatility products: Chart created by Nathan Buehler using backtesting data from The Intelligent Investor Blog . Conclusion The best advice I can give if you are thinking about trading volatility is to learn as much as you can about how these products operate. Test your strategies, document results, confirm successes, and evaluate failures. You should feel very comfortable with using these products before making your first large trade. Seeking Alpha is a great resource to use. By interacting with contributors and other users, you can create your own virtual professional learning community. I hope you have found this introduction to volatility funds useful. Now it is time to start researching and comparing individual funds. Thank you for using the SeekingAlpha ETF Guide! Scalper1 News
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