Friday, September 10, 2010

A Failed Hedging Strategy Using VXX

I mentioned about using VXX as a hedging instrument in this blog entry, as well as detailing the pros & cons of VXX.  I personally have tried out the strategy and find that VXX is very leaky ETN.  As it was pointed out by the market expert, the ETN holds short-term options expiring in 1 month and 2 months.  When VIX drops, these options become worthless and the ETN loses money.  At the same time, in order to track the VIX, the ETN has to pay a higher price to buy new options expiring in the following 1 month and 2 months.

In the scenario where S&P 500 goes bullish and continues to rise, the VXX ETN will continue to lose investor money, at a faster pace than the fall of VIX.  Even if VIX does not drop, for example, VIX hovers at around 22 points for a few months, the VXX will not be able to hold at around the same price for a few months.  Instead, it will continue to drop, even though VIX holds.

Applying the buy and hold strategy to VXX is akin to committing a financial suicide.  Your money will leak continuously.  You will be better off not buying any VXX at all.

However, does it mean VXX is no-touch ETN?  Not really.  If the market expects volatility go up, it is ok to buy some VXX to ride on the rise of volatility, but once volatility starts to fall, you must be ready to sell off all your VXX holdings, otherwise, it will hurt you, and hurt you very badly.

No comments:

Post a Comment