Limit Volatility or Use It For Profit; Here Are Some ETFs That Help You Do Both (VXX, VXZ, VIXY, VIXM, VQT)

Ron Rowland:  You’ve heard it before:  “Stocks are just too volatile right now.” So is volatility really a bad thing? And what the heck is volatility, anyway? We’ll talk about it today.

As you’ll see, volatility cuts both ways. Wise investors use it to their advantage. A new —  and growing — category of ETFs and ETNs can help you tame the wild beast.

What Is Volatility?

If we made a list of the most misunderstood investment terms, “volatility” would be near the top. When the average investor is told something like “The stock market is volatile,” what he hears is typically “It’s going down!”

This is not correct. Look it up in your favorite dictionary. You’ll see that volatility is nothing more than another word for “variability” in an investment’s value.

A price can vary either up or down while staying equally “volatile.” Volatility simply means that an asset’s price is moving. The direction in which it oves is irrelevant.

That’s what the dictionary says. However, when investors say they want to avoid volatility what they usually mean is they want to avoid losses. In fact, most people love  volatility as long as it works in their favor!

Now in real life it’s not so simple. We don’t know the future, so we don’t know how volatile an  investment will be. At best we can  make an educated guess based on past events.

Volatility in a Bottle

Your guess about volatility, while it is only a guess, does matter. If you own an asset that has  a history of suddenly jumping in value, someone who thinks another such jump is  imminent may be willing to pay you a higher price.

For this reason, professional  traders pay a lot of attention to historical volatility. They track it with  computer models and compile the results into indexes.

In the last few years, some of these volatility instruments have been packaged into exchange-traded  funds and exchange-traded notes. My latest count shows around 30  volatility-based ETFs and ETNs are now available to U.S. investors.

Are any of them right  for you? Maybe, maybe not — but they can still be useful. Just watching their  activity can help your investment strategy. Here are a few you may want to put  on your radar screen:

  • iPath S&P 500 VIX Short-Term ETN (NYSE:VXX)
  • iPath S&P 500 VIX Mid-Term ETN (NYSE:VXZ)
  • ProShares VIX Short-Term Futures ETF (NYSE:VIXY)
  • ProShares VIX Mid-Term Futures ETF (NYSE:VIXM)

While VXX and VXZ have more history, I’m wary of their exchange-traded  note structure. The ProShares offerings are very similar but do not expose investors  to issuer credit risk.

How would you use these?

All four are based on derivatives  of the S&P 500 Volatility Index — the “VIX” in Wall Street lingo. When  markets get crazy, the VIX tends to spike higher. Ideally you would want to buy  volatility before the craziness hits. Easier said than done, I know, but these  products make it easy to try your luck.

Want to Limit Volatility? ETFs Can Help You There, Too!

Suppose you’ve analyzed  your investment goals along with your personality. You know you need to be in  stocks, but you also admit you may get cold feet.

In other words, you want  some volatility but not too much. Can you participate in stocks without the full-scale  roller coaster ride?

Yes, you can, with a new  breed of volatility-controlled ETFs and ETNs. Direxion, for instance, just  launched three “volatility response” ETFs. They try to target a specific risk  level (15 percent annualized standard deviation, to be specific) by adjusting  the split between stocks and fixed-income assets.

You can pick from two  U.S. equity indexes or a Latin America index:

  • Direxion S&P 1500 Volatility Response Shares (NYSE:VSPR)
  • Direxion S&P 500 Volatility Response Shares (NYSE:VSPY)
  • Direxion S&P Latin America 40 Volatility Response Shares (NYSE:VLAT)

Barclays has an ETN with  similar objectives, but it tries to reduce volatility by moving partly into VIX  futures rather than cash-like instruments. It is called the Barclays ETN+ S&P VEQTOR ETN (NYSE:VQT).

As you can see, the ETF  industry is drilling deeper and deeper into the specialized areas once  available only to sophisticated institutional investors. Whether you want to  trade volatility or not, it’s exciting to watch this phenomenal change. Keep  your eyes open for more!

Best wishes,

Written By Ron Rowland From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss  along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its  staff  do not hold positions in companies recommended inMaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not  guaranteed. Performance returns cited are derived from our best  estimates but must be considered hypothetical in as much as we do not  track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene  Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam  Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle  Zausnig.

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