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5 Lessons Learned From VIX ETFs

The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. There are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. This index functions by measuring near-term volatility expectations from options activity on the S&P 500 Index. It’s calculated on an intra-day basis, so investors are able to watch as implied volatility expands or contracts in real time. The CBOE has a nice primer on how this is accomplished that you can read here . As many ETF investors know, you can’t invest directly in an index. So the forward-thinking asset managers at Barclays, ProShares, and VelocityShares set out to create several products to help you invest in the movement of the VIX Index. According to data from ETF.com, there are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. The two largest funds in this space are the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ: XIV ). Both of these funds currently have over $1 billion in assets under management. VXX is a bet on the expansion of volatility, which typically comes during a correction or choppy stock market action. Conversely, XIV is an inverse play that rises when volatility contracts. This fund is intended to move higher as stocks move higher and greed takes a more prominent position in investor sentiment. There are also many other flavors of VIX funds that offer varying degrees of unique tracking and index construction methodology. Nevertheless, XIV and VXX work well as benchmarks to understand this unconventional asset class. I have been watching and even invested small amounts in these funds for my personal accounts at one point or another and these are the lessons I have learned from the experience. They aren’t for the faint of heart. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. It’s difficult to use these as a forecasting tool and they are often susceptible to VERY fast swings in price . They should truly only be used by disciplined traders, investment professionals, or those who understand their unconventional nature. In my opinion, they should only be held for very short periods of time with a tight stop loss to guard against significant downside risk. They don’t track all that well. These VIX funds work by tracking futures contracts similar to a commodity fund like oil or natural gas. That in itself causes problems in accurate price movement over long periods of time as complicated forces like contract rolls, contango, and expenses work against these products. The chart below depicts an overlay of the actual CBOE VIX Volatility Index and VXX. The movements are certainly correlated to a degree, but you can see how over time the price of the exchange-traded product continues to decay versus the spot price of the index. They aren’t cheap. The listed annual expense ratio of VXX is 0.89% and XIV is 1.35%. It should be expected that a fund investing in futures contracts will naturally generate higher expenses because of the complicated nature of the process. Nevertheless, it’s important to understand that these funds are going to eat into your pocketbook as well. Some come with tax headaches. Most of the investable VIX funds are structured as exchange-traded notes, which do not experience adverse tax consequences. However, if the fund is structured as an exchange-traded fund, it may be susceptible to tax consequences in the form of a K-1 that must be accounted for as well. The K-1 is generated because you are participating as a shareholder in a partnership rather than a trust. It goes without saying that you carefully read the prospectus before investing in any of these funds. They are entertaining to watch. Regardless of whether you use these vehicles, they can be entertaining to watch and also offer some insight into the market’s fickle machinations. VIX ETNs allow individual investors the ability to monitor in real time the current sentiment towards stocks and may provide a piece of the puzzle for short-term traders. They also offer a technical dynamic that may be useful for investors who are fans of relative strength or other momentum indicators. Sharp inflection points in the VIX may point towards a turning point in the market that precedes a big move (up or down). The bottom line is that these products are primarily geared for advanced users with a high tolerance for risk and sophisticated knowledge of the markets. Those that choose to dabble in these funds should only do so with a well-defined risk management plan that protects your capital in the event of a reversal.

Oil ETFs To Watch As Crude Slips To Below $40 Again

U.S. crude again trickled to below $40 per barrel on Wednesday following the bearish inventory storage report from EIA that has deepened global supply glut and amid fresh fears that the world’s largest oil producers will not cut production when they meet on Friday. The prospect of interest rates hike and the resultant surge in dollar added to the woes. As such, U.S. crude plunged 4.6% on the day while Brent slumped 4.2% to the nearly seven-year low. The inventory data showed that U.S. crude stockpiles unexpectedly rose by 1.2 million barrels in the week (ending November 27). This marks the tenth consecutive week of increase in crude supplies. Total inventory was 489.4 million barrels, which is near the highest level in at least 80 years. As the Organization of the Petroleum Exporting Countries (OPEC) is due to meet on Friday, the market is not expecting the members to arrest production. Instead they are expected to pump oil vigorously to protect their market share. If this happens, crude will continue to be in a free-fall territory like it was last year when OPEC had decided not to cut production. However, Saudi Arabia and its Persian Gulf allies are willing to cut back if other producers like Iran, Iraq, and Russia join them in the mission. In fact, at the meet, Saudi Arabia may propose a cut of 1 million barrels per day in the OPEC output to strike a balance in the oil markets. Outlook Remains Bleak The current fundamentals are not in favor of oil with rising output and waning demand. This is especially true as OPEC is pumping record oil since Saudi Arabia and other big producers are focusing on market share. Iran is looking to boost its production once the Tehran sanctions are lifted. Meanwhile, oil production in the U.S. has been on the rise and is hovering around its record level. On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world’s biggest consumer of energy – China – will continue to weigh on the demand outlook. Notably, manufacturing activity in China shrunk for the fourth straight month in November to a 3-year low. The International Monetary Fund recently cut its global growth forecast for this year and the next by 0.2% each. This is the fourth cut in 12 months with big reductions in oil-dependent economies, such as Canada, Brazil, Venezuela, Russia and Saudi Arabia. That being said, the International Energy Agency (IEA) expects the global oil supply glut to persist through 2016 as worldwide demand will soften next year to 1.2 million barrels a day after climbing to five-year high of 1.8 million barrels this year. ETFs to Watch Given the bearish fundamentals and the OPEC meeting tomorrow, investors should keep a close eye on oil and the related ETFs. Below we have highlighted some of the popular ones, which could see large movements ahead of the OPEC decision: United States Oil Fund (NYSEARCA: USO ) This is the most popular and liquid ETF in the oil space with AUM of over $2.5 billion and average daily volume of over 25.7 million shares. The fund seeks to match the performance of the spot price of WTI. The ETF has 0.45% in expense ratio and lost 3.6% in the Wednesday trading session. iPath S&P GSCI Crude Oil Index ETN (NYSEARCA: OIL ) This is an ETN option for oil investors and delivers returns through an unleveraged investment in the WTI crude oil futures contract. The product follows the S&P GSCI Crude Oil Total Return Index, a subset of the S&P GSCI Commodity Index. The note has amassed $813.3 million in AUM and trades in solid volume of roughly 3.7 million shares a day. Expense ratio came in at 0.75% and the note was down 3.3% on the day. PowerShares DB Oil Fund (NYSEARCA: DBO ) This product also provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The fund sees solid average daily volume of around 311,000 shares and AUM of $477.9 million. It charges an expense ratio of 78 bps and lost 2.9% in Wednesday’s trading session. United States Brent Oil Fund (NYSEARCA: BNO ) This fund provides direct exposure to the spot price of Brent crude oil on a daily basis through future contracts. It has amassed $82.7 million in its asset base and trades in a moderate volume of roughly 109,000 shares a day. The ETF charges 75 bps in annual fees and expenses. BNO lost 3.7% on the day. Original post .