November 3, 2013

Kass: Nix the VXX

I have received a number of inquiries from subscribers on whether iPath S&P 500 VIX Short-Term Futures ETN (VXX) should be purchased given the complacency that exists today.

My answer is no. I would rather be short SPDR S&P 500 ETF Trust (SPY) -- in fact, I currently am -- and what follows is my explanation. There is little question that the implied volatility of stocks is very low now, both on an absolute basis and relative to the last year. This reflects the consensus view that market risk is low and that the market has climbed consistently to new highs.

In recent periods, the implied volatility (VXX) has risen only when stocks have corrected meaningfully. Small pullbacks have had a limited impact on the VXX. In the last week and a half, the realized volatility has been 6% with implied at 12%. Seasonally, November-December tends to experience low realized volatility. The VXX is based on VIX futures, which embed a very high forward premium and possess a large negative carry. As an example, the VIX is 13.41 but January forward VIX is 16.85. So if the market is flattish between now and January, the negative roll yield is rotten. Additionally, the long VIX futures have a skew delta, so as the market rises toward higher strike prices, implied volatility falls. This means if you are long VXX, it is the equivalent of being short the stock market coupled with large negative carry.

Stay away from the product.