Friday, August 28, 2015

Be Careful Trading VXX and UVXY

From Our August 2015 E-mail Archives: One of our traders had a question about trading volatility. Our Senior Risk Manager, Corey, replied with a detailed explanation of why Maverick Trading trades VXX and UVXY differently than other assets in the market.*

-----Original Message-----

From: Roman F.
Subject: Trade Alerts


Thank you for the ideas and updates, I check them every time.

I have one question about today's ideas: VXX. I constantly trade it and would like to confirm something. It looks like it's overbought and reached the resistance levels, but it opened above 17.00 today and still trending above this level. Why did Maverick Trading go long puts for 16.00 (delta 0.31, theta 0.02)? I have entered this position today with long puts at 18.00 (delta 0.51, theta 0.02).

If you have a chance, could you explain it for me?

Thank you in advance,


-----Reply Message-----

Hi Roman,

Thanks for the question. We trade VXX [iPath S&P 500 VIX Short-Term Futures ETN (Exchange Traded Note)] a little differently than we would most other assets in the market. The reason is that this is a flawed asset that is nearly always on its way to zero.

I have included a chart to the right (click the chart to make it larger) that shows VXX since its first trading day. It appears that the shares first started trading in 2009 for around $6,500 per share.

Did they bring this to market at such an expensive share price? The answer is of course, "No." This simply shows what one share was worth in 2009 compared to what it would be worth today. In other words, for every $6,500 invested in VXX in 2009, it is worth around $17.50 today (a loss of 99% of your investment).

The creators of the VXX reverse split this ETN whenever the share price drops. So, if you bought 100 shares at $100/share, then you have invested $10,000. If the shares fall to $10.00/share, then your $10,000 is only worth $1,000 today. If they come in and reverse split the stock, it won't help or hurt your situation. If they take that now $10.00/share price and boost it back up to $100.00/share ($10 x 10 = $100), then they will divide your share count by 10 at the same time. So, you now will only own 10 shares of the $100/share stock. If the stock falls again and again and again and they keep reverse splitting the stock, then you eventually have fractional shares (and essentially nothing).

The VXX and UVXY [ProShares Trust Ultra VIX Short-Term Futures ETF (Exchange Traded Fund)] work differently than most ETFs. This is due to their not really being able to "own" anything. A stock ETF is backed by shares of the companies that it tracks. Gold ETF is backed by Gold. VXX and UVXY track volatility, which is only a market gauge. In addition, VXX and UVXY have to use the futures to track volatility. Since volatility trades in "contango" (i.e., long-term volatility is a lot more expensive than short-term volatility), this is not a good thing.

To track volatility, both VXX and UVXY have to constantly buy expensive and sell cheap futures contracts. This creates a negative yield in VXX and UVXY that, over time, has them always going to zero (although they counteract this by constantly reverse splitting the shares). You can make money bullishly on VXX or UVXY only when there is a gigantic increase in volatility and even then you might not be able to outpace the decay.

In summary, we would be very careful and suggest avoiding VXX and UVXY as bullish candidates for the reasons above. However, trading them to the downside can be very advantageous.

I hope this helps.


* NOTE: Some original wording has been modified for legibility.