Tag Archives: force-majeure

Volatility Surges 35% On Grexit Fears: It’s Time To (Start) Shorting The VIX

The VIX surged 35% on Monday, its largest jump in over 2 years, as US markets shed 2% amidst worries that Greece will leave the Eurozone. This article analyzes Monday’s VIX spike in the context of previous volatility spikes and discusses the advantages, disadvantages, and risk/reward profile of a volatility short position. A short volatility position will earn most of its profits from mean reversion with minimal contango-generated rollover profits, but historically carries a reduced risk for further volatility surges. My positions and trading strategy along with entry and exit criteria are discussed in detail. As Greece teetered on the brink of default and ejection from the Eurozone, volatility surged on Monday, rattling US markets out of the summer doldrums. The Dow Jones fell 350 points or 1.9%, the largest one-day drop in 2 years, leaving the index in negative territory for 2015. The S&P 500 also took it on the chin, slumping 2.1%, and at 2,058 is at its lowest point since April 2. As a result, the CBOE S&P 500 Volatility Index (VIX) surged 34.5% to 18.85, the largest one-day spike since April 2013 and highest close since February 2, 2015. Unsurprisingly, there was fear aplenty on Wall Street on Monday. However, as the saying goes “buy when there is blood in the streets” – or in this case, sell. Due to its tendency towards mean reversion, sudden spikes in the VIX often represent opportune times to bet on the VIX correcting lower. This article discusses the mechanics behind the VIX and analyzes historical surges in volatility to assess the risk & reward of betting against the VIX following Monday’s big move. Before going further, it is necessary to discuss what exactly the “VIX” is. When referenced by journalists and even some investors, there is often confusion regarding its units with some authors putting a “$” and others leaving it as a unit-less number. Rarely, however, is the correct punctuation used – a “%” sign. The VIX is actually a percentage. It implies a 66% chance of the S&P 500 moving the percent value of the VIX over 12 months. This can be converted to 30-day implied volatility by dividing by the square-root of 12. So, based on Monday’s VIX close of 18.85, the S&P 500 has a 66% chance of moving up or down 5.44% over the next 30 days. Thus, the market expects that there is a one-in-three chance that the S&P 500 will close below 1,946 or above 2169 30-days from now, versus Monday’s closing price of 2058. How has VIX implied probability fared over the last year? Quite poorly, actually. Even with Monday’s abrupt drop, the S&P 500, as measured by the SPDR S&P 500 ETF (NYSEARCA: SPY ), has gone 73 days without the VIX’s implied volatility verifying. On May 15 – 30 trading days ago – the VIX was at 12.38 which implied a 30-day move of 3.6% in the S&P 500. As of Monday, we had only seen a 3.4% move. This 73-day streak is the longest since SPY began trading in 1993. Figure 1 below plots implied versus observed volatility over the past year. (click to enlarge) Figure 1: Implied vs. Actual volatility showing that since January, observed volatility has trailed implied volatility [Source: Chart is my own, data from Yahoo Finance] Not that observed movement in SPY exceeded that predicted by the VIX during last Fall’s market turbulence, but since the New Year, it has largely underperformed implied volatility leading to a steady decline. The point is, recent observed volatility has underperformed predicted volatility over an extended period. One of the aspects of the VIX that make it unique as an index is that fear is cyclical. Fear and uncertainty don’t last forever and neither does complacency. Inevitably, uncertainty relaxes – either Greece leaves the Euro or it doesn’t – and volatility pulls back to some mean value. Likewise, when markets become too complacent, inevitably some event – such as the Grexit – occurs resulting in volatility rebounding. In other words, when the VIX climbs too high, it corrects downward, and when it falls too low, it rebounds. Figure 2 below shows median VIX 30-day performance based on initial value for the periods 1993-2015 and 2010-2015. (click to enlarge) Figure 2: 30-day VIX performance based on starting value showing strong tendency to mean revert once the VIX reaches 17-18 over the last 5 years, and 24 since 1993. [Source: Chart is my own, data from Yahoo Finance] Note that at very low VIX levels – such as 12-13 or 13-14 – the VIX has a tendency to climb over the next 30 days, while at higher levels, it tends to decline. The point at which the VIX begins to decline is dependent upon our period of record. During the entire period of record – 1993 to present – the VIX didn’t show significant 30-day declines until it reached about 24. Over the last 5 years, however, it showed significant reversion as low as 17. Based on Monday’s close of 18.85, this simple model would predict a 2% decline over 30 days using 1993-2015 data, but a 6% decline using 2010-to-present data. Let’s examine this more closely. As shown above, mean reversion plays a large role in the VIX. However, this “mean” value can fluctuate depending on the overall market. Figure 3 below shows the VIX over the past six years along with its 1-year average value. (click to enlarge) Figure 3: VIX versus 1-year average since the latest bull market began in 2010. Note that Monday’s VIX is 28% above the 1-year average of 14.75. [Source: Chart is my own, data from Yahoo Finance] During and following the last European Crisis in 2011, the 1-year average VIX value reached as high as 24.50. Since that time, however, the average VIX has declined and was 14.75 as of Monday’s close. Thus, the VIX at 18.85 is 28% above its 1-year average value – but would have been below the 1-year mean back in 2011. Figure 4 below shows a scatterplot of the resulting 30-day performance of the VIX based on initial divergence in the VIX from 1-year average since 2010. (click to enlarge) Figure 4: 30-day performance of VIX based on initial divergence above 1-year average. As the divergence from the 1-year average increases, the VIX tends to decline. [Source: Chart is my own, data from Yahoo Finance] Admittedly, this isn’t the highest quality data set, but it does suggest an element of mean reversion. Using these numbers, the VIX at 28% above its 1-year average would be expected to decline 8.9% over the next 30 days. Let’s narrow our focus and look at VIX performance following large single-day spikes in volatility such as the one we saw on Monday. Since 1993, there have been 16 daily spikes in the VIX greater than 30%. Figure 5 below shows the performance of the VIX following these spikes, sorted by year. (click to enlarge) Figure 5: Implied Vs. Actual volatility showing that since January, observed volatility has trailed implied volatility [Source: Chart is my own, data from Yahoo Finance] Of these 16 occasions, the VIX has declined over the next 30 days in 14 out of 16 episodes, or 88% of the time with a median decline of 19.8%. Further, since the Flash-Crash in May of 2010 triggered a nearly 50% rally in the VIX subsequent to an April 2010 VIX spike, the VIX has fallen following a 30% one-day rally such as Monday’s the last 8 consecutive times with a median loss of 22%. Before discussing how best to invest using this data, I would like to present one final piece of data. Figure 6 below plots every > 10% one-day move in the VIX against the performance of SPY on that day since 2010 (115 occurrences). The red dot shows Monday’s VIX/SPY performance. (click to enlarge) Figure 6: VIX vs. SPY daily performance since 2010 showing that as SPY declines, the VIX tends to rally. However, Monday’s 35% rally in the VIX was much larger than predicted based on the SPY’s 2.1% decline. [Source: Chart is my own, data from Yahoo Finance] Granted, there is not a strictly linear relationship between the two, but, generally, as the magnitude of the loss in SPY increases, so does the jump in the VIX. However, note that the red dot representing Monday lies well above the trendline. This suggests that, based on the last 5 years of data, Monday’s jump in volatility was out of proportion to the decline in SPY. In fact, based on the dataset, a 2.1% decline in SPY would correlate with only a 19% jump in the VIX, nearly half of what verified. There are two possible explanations. First, due to recent tranquil conditions, the VIX was very low last week, below its one-year average of 14.75, at 14.02 as of Friday’s close, meaning that it had a lot of “catching up” to do to reach “market crisis” levels. Second, a nation leaving the Eurozone has never happened before, injecting substantial uncertainty into the mix, especially given the relatively small size of Greek’s economy. Nobody knows what the impact of a nation leaving the Eurozone will have on the other member nations with larger economies, and their trading relationship with the United States. In summary, the VIX shows a strong tendency to mean revert following spikes in volatility. This was evaluated based on the magnitude of VIX value, the divergence from a 1-year mean value, and following large one-day spikes, all of which showed a strong tendency towards mean reversion once values reached Monday’s close of 18.85. Further, Monday’s domestic market declines weren’t all that impressive given the 35% rally in the VIX suggesting that volatility may have gotten away from itself a little bit. If you believe that this is the beginning of a broad market collapse, further spikes in volatility may be to come. However, if you believe that the US will weather the fallout from Europe and markets will settle down as it has following similar spikes over the last few years, betting on a declining VIX following Monday’s surge is a high-probability play. What is the best way to get short the VIX? Unfortunately, there is no direct way to invest, long or short in the spot VIX. The AccuShares Spot CBOE VIX Up (NASDAQ: VXUP ) and Down (NASDAQ: VXDN ) shares were released last month with an objective to track the spot VIX (and inverse spot VIX for VXDN). Unfortunately, as I discussed in my Article Last Week , these ETFs have woefully underperformed. VXUP and VXDN gained 8.0% and lost 7.78% Monday, respectively. The best option is VIX Futures-based ETFs. Investors shorting these products benefit not only from mean reversion, but also from contango-mediated rollover loses. When volatility is low, contango tends to be high, meaning that investors short at that time are likely to benefit from large rollover losses, but will be at risk from sudden surges in volatility, such as what was seen on Monday. Unfortunately, following volatility spikes, contango tends to diminish. Figure 7 below shows VIX futures contracts for the next 4 months. (click to enlarge) Figure 7: VIX futures contracts for July 2015 through December 2015 showing that Monday’s spike in volatility effectively erased the long-standing contango that had dominated to futures market. [Source: Chart is my own, data from Yahoo Finance] The current front-month contango is a negligible 0.3%, down from 6.5% on Friday. Subsequent months are not that much better with total rollover losses over the next 5 months under 6%. As a result, the majority of near-term profits from a short volatility position will be from mean reversion until the VIX declines to a point where contango becomes an issue again. Fortunately, as discussed above, there is a very high probability of mean reversion going forwards. The most popular volatility ETF is the iPath S&P 500 VIX Short-Term Futures ETF (NYSEARCA: VXX ), which holds front-month and T+1 contracts. The ETF gained 17.1% Monday to $20.31 and is now trading at its highest level since early May. Let’s apply the same historical analysis as Figure 5 above, showing the 30-day performance of VXX following > 30% volatility spikes. Figure 8 below shows the median 90-day performance of VXX for 9 events that have occurred since VXX began trading. (click to enlarge) Figure 8: 90-day median performance of VXX following 9 > 30% VIX spikes since 2010. Note a maximum drawdown of 10% for a VXX short position and a 20% profit after 90 days. [Source: Chart is my own, data from Yahoo Finance] Over 90 days, VXX returned a median 18.1%. Note that the return is slower and choppier than the VIX returns seen in Figure 5, but that the trade is ultimately a winning one, despite the fact that 3 of the VIX spikes occurred in 2011, a period of historically elevated volatility during the last European Crisis. To be clear, the objective of this article is to show that Monday’s VIX spike represents an ideal entry point for a volatility short position, not a risk free-one. To evaluate potential losses, let’s imagine that a Greece exit from the Eurozone triggers a repeat of the 2011 European Crisis. After bottoming at 12.5 on 6/23, the VIX has since surged 51% as of Monday’s close. In 2011, the VIX bottomed at 15.3 on July 7, but took nearly 2 months to rally 50%, reaching that point on August 5, 2011. We will use that as a starting point and plot returns of VIX and VXX from there until volatility peaked to evaluate potential losses for a VXX short position initiated on Monday. This data is shown below in Figure 9. (click to enlarge) Figure 9: Summer 2011 returns for VIX and VXX after initial 50% VIX spike – i.e. our current situation – showing maximum 85% VXX drawdown before mean reversion. [Source: Chart is my own, data from Yahoo Finance] As the data shows, should the current crisis blow up to 2011 proportions, VXX short positions have potential to lose in excess of 80% before volatility mean reverts. Ultimately, the trade would be a winning one, but investors would have had to endure large paper losses prior to that point. Note that, in a somewhat unusual occurrence, VXX actually outperformed the VIX, which was likely due to a contribution from backwardation, as rollover losses became rollover profits for a short period of time. For those, anxious about shorting a volatility product into a dangerous market, an alternative investment would be a long position in the VelocityShares Daily Inverse ETF (NASDAQ: XIV ) which declines as the VIX increases, meaning that losses shrink as the VIX increases and are limited to 100% if the product goes to zero. I prefer short VXX to long XIV because, while both mean revert and capitalize on contango, XIV underperforms over the long term as I discussed in This Article due to the process of creating the inverse ETF. For investors looking for a lower volatility ETF than VXX, a short position in the iPath S&P 500 Medium-Term Futures ETF (NYSEARCA: VXZ ) or a long position in the VelocityShares Daily Inverse Medium-Term ETF (NASDAQ: ZIV ), which hold less volatile T+3-T+6 contracts may be more appropriate. Despite the added advantage of leverage-induced decay, I would recommend avoiding the leveraged VelocityShares Daily 2x VIX Short-Term ETF (NASDAQ: TVIX ) due to the potential for > 100% losses should volatility continue to spike before mean reverting. When the VIX eclipsed 18 Monday afternoon, I initiated a small short position in VXX at an average price of $20.25 worth 5% of my portfolio. I believe that this is not a time for bulk purchases and plan to slowly increase my position should the VIX continue to spike. I will add small positions at 10-15% VIX intervals until the position reaches 12% of my portfolio. Should the Greek crisis devolve into a continent-wide crisis that threatens to lead to a long-term increase in volatility, I will plan to exit the position and cut my losses. In conclusion, I believe that Monday’s VIX spike represents an ideal entry point due to the historical high-probability for mean reversion. I recognize that relying on history is not always a sound strategy and will therefore closely monitor market sentiment and will be prepared to cut my losses if need be. That being said, I expect volatility will revert to its recent historical average of 14-15 and will plan to hold my VXX short position to initially capitalize on mean reversion and subsequently rollover-mediated losses. Disclosure: I am/we are short VXX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Trading The VIX: I Want Volatility With My Volatility ETF

On May 19, AccuShares rolled out two new volatility ETFs–VXUP and VXDN–that were advertised to track the spot VIX without suffering the losses that plague conventional volatility ETFs like VXX. It has now been 1 month since these funds started trading and while VXUP and VXDN have achieved a portion of their objective, they have failed spectacularly in another. This article discusses the mechanics of VXUP and VXDN, compares their performance over the past month to the spot VIX and VXX, and offers alternative investment ideas. Investing in the VIX has long been a challenge for investors. Because direct investment is not possible for the average trader, an assortment of ETFs have been created to facilitate the process. The most popular of these is the iPath S&P 500 VIX Short Term Futures ETF (NYSEARCA: VXX ), although many others, including inverse and leveraged products, are also available. Unfortunately, these ETFs are all based on VIX futures contracts and inevitably underperform the VIX over the long-term, making them exceptionally difficult investments. I was therefore very excited to learn that a new pair of VIX ETFs would be entering the marketplace in mid-May that were designed to track the spot price of the VIX and to avoid futures contracts. One, the AccuShares Spot CBOE VIX UP Shares (NASDAQ: VXUP ) was designed to directly track the spot VIX while the other, the AccuShares Spot CBOE VIX DOWN Shares (NASDAQ: VXDN ) would trade inversely to the spot VIX. Could these be what volatility ETF investors have long been waiting for? It has now been one month since these new products began trading. This article analyzes the performances of VXUP and VXDN in their first month of trading and compares them to the spot VIX and VXX. VIX ETFs that use futures contracts to track the VIX are limited by the fact that VIX futures contracts expire after one month. As a result, these funds must sell their contracts by the end of each month and rotate them into the next month’s futures contract. They typically do this on a daily basis, rotating between 4% and 5% each day to rotate the entire equity of the fund in each 20- or 25-day month. Unfortunately, the VIX futures market usually trades in a steep contango, a situation where subsequent contracts are more expensive than current contracts. Figure 1 below shows the current VIX futures contracts for the next six months as of Monday’s close showing this contango. (click to enlarge) Figure 1: VIX Futures Contracts for July through December as of Monday’s close showing persistent contango with the August contrast nearly 7% more expensive than the August contract. [Source: YahooFinance ] The August 2015 futures contract is trading at a 6.8% premium to the current front month July 2015 contract. As a result, VXX is currently selling July 2015 contracts and using the funds to buy August 2015 contracts. As of Monday evening, the fund holds 82% July contracts and 18% August contracts. Over the coming weeks it will rotate 4% of its funds per day from July into August contracts. As a result, the fund is effectively selling low and buying high. Should the contango hover around 7%, the fund will suffer a daily loss of 0.04 * 0.07, or 0.28%. This is a small loss for those trading these funds on a short-term basis, but over time it adds up. Figure 2 plots VXX versus the front-month VIX contract it is designed to track over the last 1 year. (click to enlarge) Figure 2: VXX versus VIX over the past 1 year showing steep underperformance of VXX due to rollover losses. [Source: YahooFinance ] As the data above shows, VXX massively underperforms the front-month VIX futures contract, losing 41% over the last year while the VIX gained 13%. With 260 trading days, the 28% underperformance amounts to a 1-year average of 0.11% per day. This is a significant amount of drag for an investor long VXX waiting for a volatility spike. The natural gut reaction to this data would be to just short the ETF and kick back and let the profits roll in. However, this is also an inherently risky strategy. While VXX may underperform over the long-term, it can spike dramatically during market swoons. For example, during the summer of 2011 during the European Crisis, VXX jumped from $331 on July 22 to $909 on October 3, a short-breaking 174% gain. With the VIX trading at 12.74 as of Monday’s close well below its long-term average of 19 and with Greece teetering on the edge of another crisis, I would be reluctant to be short here. Due to this challenging set of trading conditions for ETFs such as VXX, investors have long clamored for an alternative ETF that did not have the limitations of futures-based VIX ETFs. Enter AccuShares. On May 19, the company released VXUP and VXDN for trading. Unlike VXX and its ilk for which the underlying index is the front month VIX Futures contracts, the underlying index for these two ETFs is the CBOE Volatility Index itself, the VIX. This should, in theory, prevent rollover losses. The management of the two is very complex. Briefly, VXUP and VXN operate as a pair and swap assets back and forth as the VIX fluctuates. Neither fund holds futures contracts, but just cash and cash equivalents such as treasuries. Each of the funds operates around a “Distribution Period” on the 15th of each month, at which point the value of the fund that gained the previous month is adjusted with payout of a cash dividend reducing its value to that of the declining fund. For example, let’s say that VXUP and VXDN each start the month out at $20/share and the VIX starts at 15. The VIX rallies 20% to 18. VXUP would be predicted to rise to $24 and VXDN would be predicted to decline to $16. At the end of this month, holders of VXUP would receive a $8 dividend in either cash or in an equal value of VXDN and the value of VXUP would be adjusted to $16, and both funds would start the next monthlong period at the same price. Finally, if the VIX is less than 30 (which it almost always is), 0.15% is transferred from VXUP to VXDN on a daily basis to provide an incentive to invest in the inverse ETF. The reasoning is that the VIX will eventually spike and investors are therefore less likely to want to buy-and-hold VXDN. At least, that is how everything is supposed to work in theory. However, this is not a discussion on the complex mechanics of these funds, but rather an analysis of their performance. Between May 19 and June 22, the VIX was remarkably flat, declining just 0.9% over the monthlong period. During the same period, VXUP declined 1.5%, a small 0.6% underperformance. VXDN gained 0.4%, a 0.5% underperformance. In contrast, VXX declined 8.8%, a much larger 7.9% underperformance. Further, VXUP and VXDN did not seen the same decay that plagues VXX and similar funds. Figure 3 below compares the monthly performance of VXUP and VXDN along with an “average” percent return between the two. If there was inherent decay and underperformance, the “average” return would be expected to steadily decline. For example, VXUP and VXDN might initially be up or down 4%, respectively, but by the end of the month would be up 8% and down 12%, respectively, for an “average” of -2%, indicating decay. (click to enlarge) Figure 3: VXUP and VXDN performance over the past month along with an average of the two showing minimal decay of the funds that would be expected of a fund based on Futures contracts such as VXX. [Source: YahooFinance ] Based on Figure 3, VXUP and VXDN trade in nearly perfect opposition over the course of the month with the average percent return between the two flat near zero indicating minimal decay. Based on these performance numbers alone, these two new ETFs look promising. However, this does not paint the entire picture. Figure 4 below plots the percent change in VXUP versus VIX over the past month. (click to enlarge) Figure 4: VXUP versus VIX over the past month showing the large volatility shortfall of VXUP compared to its underlying index. [Source: YahooFinance ] The data above shows that VXUP significantly underperformed VIX during periods of increased volatility. For example, on June 8, the VIX spiked 7.6%, but VXUP was only able to manage a 0.8% gain, barely 1/10th of the VIX’s performance. On June 15th, the VIX rallied 11.7% with VXUP gaining 3.4%, better but still an awful underperformance. Thus, the fact that VIX and VXUP both finished the month with nearly equal 1% declines is merely a function of the VIX trading flat and is unrelated to effective tracking by VXUP. To illustrate, if instead of a month range, we use the period of May 21 to June 15, the VIX gained 27% while VXUP only climbed 0.6%. In the fund’s defense, between June 15th and June 22, the VIX fell 17% while VXUP only dropped 4%. Thus, VXUP is not necessarily underperforming the VIX, it simply appears to be less volatile than the VIX. Unfortunately, volatility is what makes the VIX ETFs so popular. To analyze VXUP’s performance further, Figure 5 below shows a scatterplot of VXUP daily performance vs VIX daily performance. (click to enlarge) Figure 5: Daily performance of VIX versus VXUP over the past month showing diminished volatility of VXUP as well as mediocre tracking compared to its underlying index. [Source: YahooFinance ] This data highlights two important points, neither of which is favorable for VXUP. First, note the shallow slope of the trend line in the figure. This approximates the beta of VXUP relative to the VIX. Beta is traditionally thought of as a measure of the volatility of a security or portfolio in comparison to the market as a whole. A stock with a beta of 1 indicates that a stock’s price movement will mimic that of the market – if the S&P 500 gains 5%, the stock will gain 5%; if the market is flat, the stock will be flat; and if the market falls 5%, the stock will fall 5%. A stock with a beta of 2 is more volatile than the market – a tech stock, for example – and will gain or lose twice that of the S&P 500 or whatever index is used as the benchmark. A beta of 0.5 is comparatively less volatile – a utilities stock, for example – and will gain or lose half of the market’s performance. Betas can also be calculated for one stock or ETF versus another stock or ETF. Let’s calculate the beta for VXUP relative to VIX. If the Beta is 1, this means that VXUP sees daily gains and losses comparable to that of the VIX. We already know what the result is going to be. Unfortunately, the beta for VXUP over the past month has been 0.21, meaning that the fund is only about 1/5th as volatile as the index it is trying to track. In other words, its creators successfully sought to eliminate decay and underperformance, but eliminated all-important volatility and opportunity for outsized gains that makes VIX products so popular investors. Second, Figure 5 also shows that VIX and VXUP don’t really correlate all that well as there is significant scattering around the trend line. The R^2 for the relationship is a lackluster 0.68 indicating a poor day-to-day tracking. In fact, VXUP isn’t all that much better than an ordinary Index ETF, both in terms of approximating the volatility of the VIX and effectively tracking its day-to-day movement. Let’s perform the same calculation as in Figure 5 using the SPDR S&P 500 ETF Trust (NYSEARCA: SPY ), the oldest and most popular index ETF, instead of VXUP. A scatterplot comparing daily movement of VIX versus SPY is shown below in Figure 6. (click to enlarge) Figure 6: Daily performance of VIX versus SPY over the past month showing comparable volatility of SPY and VXUP (shown in Figure 5). [Source: YahooFinance ] Note that SPY actually tracks the VIX more accurately on a daily basis than VXUP with an R^2 value of 0.79 vs 0.68 for VXUP, although of course the relationship between the two is inverse in that SPY goes down when the VIX goes up. The beta for SPY to the VIX is -0.08 compared to 0.21 for VXUP indicating similar levels of volatility. If one wanted to approximate VXUP’s volatility even more closely using an index ETF, a trader could go long the inverse leveraged Direxion Daily S&P 500 Bear 3x ETF (NYSEARCA: SPXS ) which has a beta of 0.23 and an R^2 of 0.80 relative to the VIX, beating VXUP on both fronts. What conclusions can be drawn from this data? On the one hand, VXUP and VXDN have, after 1 month, avoided the decay from rollover losses that plague Futures-based VIX ETFs like VXX. However, the ETFs have come up woefully short in tracking the day-to-day performance of the spot VIX and matching its volatility, which is what they were advertised to do. In fact, if a trader wants to be free of the rollover-induced decay seen in VXX and approximate the level of volatility seen in VXUP over the past month, he or she is better of shorting a simple index fund such as SPY or buying an inverse index ETF such as SPXS as these have better daily tracking than VXUP and comparable levels of volatility. To be compared to an index fund–intended to be a stable, non-volatile long-term investment for those actively trying to AVOID volatility seen in individual stocks–is a giant slap in the face for a volatility ETF. To put it more succinctly: I want volatility with my volatility ETF! Yes, the funds outperformed VXX, although this could be said of most index ETFs last month. Were the VIX to have spiked, VXX would have likely outperformed VXUP by a considerable margin. While I would like to give these funds the benefit of the doubt that perhaps they will more accurately track the VIX should it start trending directionally rather than the chop that we saw last month, I consider them to be failed funds right now. It is one thing for a fund like VXX to underperform its underlying commodity. Traders know why it does so and accept that underperformance as the cost of the opportunity for volatility exposure. VXUP/VXDN, on the other hand, are more than five-fold less volatile than expected, and it is not clear why. AccuShares had announced plans for similar paired funds for oil, natural gas, metals, and agricultural commodities, but I expect these ETFs will be tabled for now. Where does this leave us? To be honest, I believe trying to get long the VXX is a fool’s errand. Too much comes down to timing. VXX may track the VIX much better than VXUP–it has a beta of 0.41 with an R^2 of 0.89 relative to VIX–but it is suffers the rollover-induced drag discussed above. While the VIX will inevitably spike, waiting for it to do so long VXX can be very costly and not only holds your funds captive, but the eventual volatility spike might not even be enough to overcome rollover losses. The only situation in which I would consider going long VXX would be if the VIX were less than 12, more than 2 standard deviations below its long-term average. Over the last 25 years, when the VIX is less than 12, it rallies an average of 13% over the following month, rising 79% of the time, a high probability jump with a large enough magnitude that would likely outweigh any rollover-induced losses. With the VIX closing at 12.74 on Monday, we may actually be approaching this level. At the same time, I would be very reluctant to short VXX at these levels, even with a 6% monthly drag due to contango given the increased probability of a volatility spike. I prefer the higher probability play and would only consider shorting VXX if the VIX climbed above 20, which would limit further upside risk and allow profits both from rollover losses and any mean-reversion that takes place as volatility subsides. In the meantime, I believe that there are much better investments out there that do not come with the same risks as VXX or the limitations of VXUP. In conclusion, VXUP and VXDN were an admirable attempt by AccuShares to create a novel volatility product that was not dependent on VIX futures contracts and the disadvantages that come with these contracts. However, to date, it has failed to even come close to meeting its objective of tracking the spot VIX on a daily basis. The volatility of VXUP to date is so underwhelming that an investor would just as well use index funds to achieve the same level of volatility exposure. Therefore, I plan to avoid these ETFs barring a significant improvement in daily volatility. That being said, I am not enamored with the alternatives either. While VXX is roughly twice as volatile as VXUP, it’s rollover-induce losses drain a portfolio while waiting for a spike in voltility. Put another way, VXUP and VXDN remove some of the risk of volatility ETFs but take away most of the reward. VXX has more potential for reward, but introduces extra risk in the form of rollover losses. I would only recommend going long VXX when the VIX is at historical lows. Likewise, I would only take advantage of the rollover-induced losses and short the VXX when the VIX is elevated above its baseline average to reduce the risk of a spike in volatility that would devastate a short position. In the meantime, there are over 4000 actively traded stocks in the NYSE and Nasdaq. There are at least a couple that are better bets than trying to force the issue with volatility right now. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.