Nearly 5 years ago, I noted how the iPath S&P 500 VIX Short-Term Futures ETN (VXX:AMEX) was “Designed To Fail.” Since then, excluding some rather terrifying spikes, it has reliably melted away as I suspected that it would. If you put the position on back in 2010, you made something better than 98% on your money. If you re-weighted the position on spikes in volatility, you did a good deal better.
Longer term, this publicly traded ETN is designed to continue melting away; however, in times of increased volatility this product can not only rally aggressively, but go into backwardation where the roll yield increases the value of the equity, rather than the negative roll yield that this trade is based off of. For instance, during much of 2008, volatility was in backwardation and being short volatility was a losing proposition unless you were aggressively trading it. I’m not trying to make a market call here, but as I survey the world, between the untried experiment with ZIRP, to the pending massive write-offs caused by shale oil, to the increasingly bellicose relations in the Middle East, to the continued economic collapse of Europe and possibly China, to the unorthodox US election, to the beginning of competitive currency devaluations, to a myriad of other issues, I have to wonder if I want to be short volatility under 20. The answer is—I don’t.
For much of the past few months, the 1-2 month VIX has been in backwardation. I wouldn’t be surprised if this backwardation continues along with an overall increase in volatility. In that case, there will be another time to put this trade on. During a market crash, you want to have cash to buy bargains—not a headache caused by a short volatility position that is rapidly going against you. This has been a winner for a very long time and it’s now time to book VXX and wait for a better moment to short it again.
I have had very few investment positions for a while now, but there’s a growing list of undervalued companies that I want to own after there has been a washout. For the first time in quite some time, I’m finding exciting things to invest in. Sitting in cash worried about the global economy, as I have been for the past few years, isn’t all that entertaining or lucrative.
That’s how short vol feels when you’re on the wrong side…