Volatile VIX Should Close 2010 where it began

As we look back at the year in review, it was the best of VIX times, it was the worst of VIX times. Well, actually, it wasn’t really either one. Assuming we close somewhere near 17, the CBOE Volatility Index (VIX) will have dropped about 20% in 2010. But that exaggerates the move a bit as the VIX rallied 10% on Dec. 31, 2009. So it more or less ended about where it started. And given that we sit near the long-term mean of 20, that’s not all that odd. Nor that bad as the S&P 500 (SPX) rallied about 12% in 2010. As you can see from the chart, the VIX made a pretty interesting round trip getting back to about where it started. The growing awareness of the Greek debt crisis in January led to a quick 50% pop, which had all but dissipated in April. We then saw a bigger “worry bubble” and the flash crash in early May, with the VIX tripling from low to high in about a month. But from there, we've simply stair-stepped down to the high teens we see today. In many cases, trading the VIX in 2010 was not so lucrative. The iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX ) closed at a reverse-split adjusted 136.28 in 2009, so depending on where we go out on Friday, it will have pared a cool 70%-75% of its value. That is thanks to both the constant contango drag of rolling up every day to a higher priced future so as to maintain 30-day duration, and to the gradual erosion of futures premiums themselves. Fear waned over the course of 2010 in the sense that there are no perpetual expectations of an imminent VIX surge. Or at least there’s less of an expectation. Pricing of VIX futures two cycles out saw premiums in the $6-$7 range at some junctures in 2010, and now are quoted at about $4.50, up from the recent price of about $3. The iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ ), which tracks the VIX futures four-to-seven months out, fared much better than VXX, losing only 13% of its value. VXZ has less beta than VXX, so that understates the pain a bit in that you would need to own more if you used it as a true hedge. VXZ doesn’t have the same contango drag as VXX, but it does carry the risk of an overall erosion of futures premiums . The year 2010 also saw the exponential growth of tradable volatility products. Three stand out in my humble opinion. We have the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: XXV ), an inverse VXX ETN that can actually capitalize on the afformentioned VXX issues. It has rallied 60% since its listing in mid-July. Later we got the 2x Long VIX Short-Term ETN (NYSE : TVIX ), basically a double VXX ETN. Clearly you don’t want to hold VXX for an extended period of time, but there are times when you can catch a good trade off the long side. Well, now you you can catch two times the trade! And finally, there’s the UBS E-TRACS Daily Long-Short VIX ETN (NYSE: XVIX ), an ETN that goes long VXZ versus short VXX, beta neutral. And that play exploded in 2010. Will it do the same in 2011? I have no idea, but it gives you a play on that in one shot.
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