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Ask the Editor: How Do You Trade the VIX?

The VIX is a complicated topic, and thus inspires some complicated questions. Here’s one InvestorPlace recent got on its Facebook (NASDAQ:FB) page:

“Is it true that you can only buy VXX through options?”

I spent a long time trying to craft a succinct but complete response, and after posting it decided that I’d share it here, too, for other interested readers. The bottom line that you can’t invest in the VIX directly and see 1-to-1 returns — that is, gain 5% if the VIX goes up 5% and so on. But there are ways to invest around the VIX if you so choose.

The VIX, formally Chicago Board Options Exchange Market Volatility Index, is commonly referred to as the “fear index.” But it is much different than a conventional index like the S&P 500. It’s calculated based on the short-term options people are trading on the S&P 500.

Since it is made of options and not component stocks, you can’t trade it directly like you can the S&P or Dow, making exactly 10% if the VIX goes up 10% or vice versa. You can, however, trade options and futures on the index.

So if you meant to ask if you can only do options on the VIX and simply had a typo there, then the answer is yes.

But you used the ticker symbol VXX. This product is one of many ways to you can invest in (or around) the VIX with an exchange-traded product that behaves mostly like a stock.

The VXX is the iPath S&P 500 VIX Short Term Futures ETN, and essentially trades options on the VIX for you. It goes up based on whether those options were profitable or not … which is very different sometimes from whether the VIX goes up or not.

Adding to the confusion is that the VXX is just one flavor of VIX instrument. Take the VIX Mid-Term Futures ETF (NYSE:VIXM), which has a slightly longer time frame on its options (hence the “short-term” vs. “mid-term” in their names). It also performs based on VIX options and differs from the index itself, but also differs from the VXX since it is composed of a wholly different set of options plays.

The best illustration of all this nonsense is that the VIX is down 14% year to date, the mid-term VIXM is down 23% and the short-term VXX is down 35% on the year. Clearly neither the VXX nor VIXM faithfully follows the index, nor do they follow each other.

It’s incredibly complicated, I know. But I hope this makes sense.

If you really want to get confused: You can trade options on the VXX, too. Yes, that’s right — you can trade options on an instrument that is trading options on the VIX. Makes your head spin, don’t it?

Other folks can feel free to add clarifications here in the comments. Or if you have a question of your own, please email me at editor@investorplace.com — or engage with InvestorPlace on our Twitter account or Facebook page and we’ll answer your questions there.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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