Volatility ETFs On Downhill Ride

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November 3, 2013 10:43pm NYSE:VIIX NYSE:VIXY

technical bounceThe American economy heaved a sigh of relief after it averted a costly debt default. While this sent the S&P 500 and Nasdaq into a rally, volatility ETFs took a backseat to other factors.


Along with the debt deal, reduced possibility of tapering offered a wild card entry to equities but emerged as threats to the volatility ETFs.

These products tend to do well when markets are sliding or fear levels over the future are high. As neither of these events came to pass thanks to the sluggish economic indicators in the U.S., the market does not foresee the Fed scaling back before the first quarter of next year.

Why No Taper is Likely Now

On Sep 18, the Fed stuck to its easy money policy awaiting more evidences of progress in the economy and improvement in the job market. The Fed trimmed its economic growth forecasts for this year and the next, and will continue to hold interest rates near zero until the jobless rate falls to 6.5% or lower and inflation rate goes above 2.5%.

Since then, the market is closely monitoring each and every economic movement and debating on the likely time and amount of the taper. The recent deluge of U.S. data pertaining to inflation, consumer confidence, job level and industrial production were, however, underwhelming. These suggest that the monetary stimulus will stay here at least for the near term (read: Utility ETFs: Winners After the No Taper Announcement?).

Notably, the inflation rate was 1.518% in August 2013, down sequentially. Consumer confidence in the U.S. dropped to the lowest level in 5 months in September and October, and is likely see a sharp downfall in the sentiment.

The unemployment rate fell slightly to 7.2% from 7.3% in August. Job growth in September was also lower than expected. Orders for a broad range of U.S.-based capital goods plunged in September. These languishing data elevated the expectation of a delayed taper.

Coming to the corporate front, although earnings expectations for the fourth quarter for S&P companies are shaping up decently, they are lagging previous expectations. Barring some solid results, the overall guidance was in a sub-par tone, signaling a lukewarm recovery in the U.S.

Volatility Products on Downhill Ride

Continued monetary stimulus will keep infusing cheap dollar into the economy that shifted the investors’ focus toward high-yielding equity markets. As such, volatility products saw dire trading in the last month.

The fear-gauge CBOE Volatility Index (VIX) plunged about 20% to settle at 13.41 while the S&P 500 index gained about 5.5% during this period. Below, we have highlighted three most popular products that have seen rough trading and might continue to do so in the coming days.

iPath S&P 500 VIX Short-Term Futures ETN (VXX)

This is the most popular volatility ETN on the market, focusing on the S&P 500 VIX Short-Term Futures Index. The Index offers exposure to a daily rolling long position in the first and second month VIX futures contracts.

The note has amassed nearly $1.25 billion in AUM and charges 89 bps in fees per year from investors. The product lost 12.7% over the past month.

ProShares VIX Short-Term Futures ETF (VIXY)

This fund offers investors to play on the U.S. equity market volatility one month into the future by tracking the S&P 500 VIX Short-Term Futures Index. The product has $217.8 million in AUM. The ETF charges 0.85% in expense ratio but shed 13% in the past month.

VelocityShares Daily Long VIX Short-Term ETN (VIIX)

This product also seeks to deliver the daily performance of the S&P 500 VIX Short-Term Futures Index. Being an unpopular choice, VIIX could accumulate just $11.6 million in its asset base. The ETN charges 89 bps in annual fees. It dropped by 12.8% over the past month.

Bottom Line

This is really not a good time for volatility products. However, investors should note that the resolution on the debt ceiling is a short-term respite. According to the deal, government agencies will be funded till January 15th and the debt limit will be extended till February 7th.

But after the specified period, the gridlock might be recreated, opening up the doors for volatility products. The same case holds for taper talk as well which is likely to be resumed in early next year. Till then, investors may want to ignore volatility (read: 3 Bond ETFs Popular in the ‘No Taper’ Aftermath).

This article is brought to you courtesy of Eric Dutram.


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