After being the beneficiaries of an uncharacteristically strong and lengthy tailwind, the VXX bulls may be about to receive their comeuppance. Currently there is a trio of obstacles which may finally slay the beast haunting the nightmares of VXX bears everywhere. Barring some Eurozone induced volatility spike, this triple threat is likely to hasten the long awaited return of the day-by-day demise of this increasingly popular, yet fatally flawed volatility ETN.
Threat number one comes in the form of November futures expiration slated for this Wednesday morning. The positive roll yield captured as expensive November contracts were rolled to notably cheaper December contracts is soon to be a thing of the past. What was once looked at as a benefit to the fund is now a detriment. As the front two expiration months flip from backwardation to contango, the yield from rolling from one month to the next has turned from positive to negative. With Dec VIX futures contracts trading around the 31 level and Jan trading at 32.40, a cost will be incurred as front month futures are incrementally rolled to the second month.
Threat number two comes by virtue of the calendar. From a seasonal standpoint the end of November through beginning of January is not known for epic volatility. The numerous holidays coupled with lower trading volume will likely usher in a more docile environment. While one could make the case that Dec VIX futures are already baking some of these lower vol expectations into the cake, 31 is still quite high and has plenty of room to decline if some semblance of normalcy returns to the marketplace.
The third and final threat arises from a technical observation of the market. Simply put, things are more stable. The S&P 500 Index has now been above its 50 day moving average for a month. Dips have been bought with some consistency. And we have some Q4 bullish seasonality to boot.
Throw it all together and we’re in an environment conducive to selling rallies in the VXX versus buying dips. While I wouldn’t count out the appearance of the occasional volatility spike from nowhere, I like the idea of using pops in the VXX to initiate bearish type plays. Put calendars in particular look intriguing to me here.
For related posts, readers can check out:
The Volatility Temptress
Volatility Faders Relegated to the House of Pain
VXX Reflections
{ 2 comments… read them below or add one }
Hey Tyler,
Just one observation. The flip back into contango will only be in the front months, so unless your other 2 factors come together nicely, I wouldn’t call for the demise just yet..
Would you mind elaborating on the put calendar idea?
Thanks,
Baruch
For the put calendar I’d go out to March and buy an ITM put somewhere around the 46 strike and then look to sell a Dec OTM put against it.
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