Despite a GDP contraction, extreme measures by the ECB, and just good (not great) jobs numbers, U.S. stocks continue to slowly march higher. In fact, the S&P 500 hovering around 1,950, putting the key American benchmark within striking distance of the psychologically important 2,000 level.
While this has been welcomed news for many equity investors—especially after the recent bout of turmoil—those that have made a bet on volatility in this time frame have been hit hard. After all, volatility levels have cratered, suggesting that many investors believe that smooth sailing is on the horizon, at least in the near term.
This poor trend is best represented by the most popular volatility exchange-traded product currently on the market, the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX). This benchmark of volatility lost about 5% in Friday trading, capping off a horrendous week for the product in which it plunged by about 9.5%.
Given this big plunge and some rockiness in the market, some might be looking for an uptick in volatility from these low levels. However, while a brief move higher is always possible, the longer term outlook for volatility investing is still pretty bleak.
Arguably one of the most important factors to consider when investing in volatility is the futures curve. That is because products like VXX much roll their exposure from month to month and thus are subject to the forces of contango (upward sloping curve) and backwardation (downward or favorable sloping curve).
When there is a lot of contango in the market, it can create a roll hurdle that is tough to overcome for many volatility products. Unfortunately, this is pretty much the case for VXX right now, especially if you look at the current futures curve (read Don’t Let These ETFs Fool You).
Current futures are trading around the 12 mark, but ones later out, such as in September for example, are at around 15. This steady slope higher makes it very difficult for products like VXX as they must buy the more expensive contracts and then watch them (generally) go down in value to the spot level, and then must repeat this month after month.