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ETFs providing exposure to the VIX Index have recorded strong gains over the past week as volatility in US equities has spiked amid a global equity market sell-off.
The VIX index has more than doubled over the past week amid a global equity market sell-off.
The VIX, known as the “fear index”, represents the implied volatility of US equities derived from option pricing on the S&P 500.
It is a measure of the market’s expectation of stock market volatility over the next 30-day period.
The VIX has more than doubled in the past week and gained over 50% in Wednesday trading alone as global equities went sharply into the red.
Equity market trouble
Rising inflation (particularly oil prices), concerns over the impact of tightening monetary policy in the US, and geopolitical tensions such as Brexit negotiations and the ongoing trade dispute between the US and China, have led to an increase in Treasury bond yields. The ten-year yield has surpassed 3% and is currently trading at levels not seen in over five years.
The boost in yields has decreased the relative attractiveness of equity investments and, with investors questioning the sustainability of the current US bull market, global equities began to tumble last week: between 4 October and close of trading on 10 October, the S&P 500, FTSE 100, and S&P Europe 350 trimmed 4.8%, 4.8%, and 4.3% respectively.
Commenting on the global market sell-off, Michael Metcalfe, Global Head of Macro Strategy at State Street Global Markets, said, “Hopes that Q4 would provide an easy end to the year for investors were always going to be optimistic. It was notable that even as US equity markets hit record highs last month – in turn helping measures of business and consumer confidence through, or in line with, cyclical highs investors were becoming increasingly cautious.
“Investors reduced their holdings of risky assets in August and September, which took our investor confidence index to its lowest level in more than five years at the end of last month. Investors were apparently concerned that all the good news was in the price and price action so far in Q4 has vindicated that caution.
“It is becoming clear that in the face of full employment and at target inflation, better US economic news will now be met with a less accommodative Fed intent on getting rates to neutral and possibly more. Meanwhile, outside of the US, the potential political pitfalls of Brexit, the Italian budget and the US-China trade dispute, continue to restrain sentiment.”
Antoine Lesné, Head of EMEA Strategy and Research for SPDR ETFs, noted that choppy trading across the firm’s European listed ETFs on the morning of Thursday 11 October suggested the storm was not over yet.
He said, “Europe is catching up on yesterday’s brutal session in the US with core euro sovereigns rallying and equities falling. Trading volumes overnight were huge, with the US market seeing the bulk of assets changing hands. For our largest exposure in US equities for example, yesterday’s volumes were 3.1 to 3.2 times the average of the past 30 days, with close to $60bn changing hands yesterday in our flagship product alone. We also saw large flows though the ETF secondary market, which typically functions as the shock absorber for market volatility.
The technology sector in the US has been particularly hard hit over the past week with the SPDR Technology Select Sector Fund (XLK US) dropping 8.5%. Similarly, the newly created SPDR Communication Services Select Sector Fund (XLC US) – which contains many household names that were previously in the technology sector such as Facebook and Google (trading as Alphabet) – has fallen 6.6%.
The slump in equities, along with the corresponding rise in uncertainty, has created an opportunity for volatility traders to profit.
VIX ETFs
In the US, the two most popular VIX-related ETPs are the $1.1 billion iPath S&P 500 VIX Short-Term Futures ETN (VXX US) and the $150 million ProShares VIX Short-Term Futures ETF (VIXY US). Both offer exposure to a daily rolling long position in short-term VIX futures contracts and come with expense ratios of 0.89% and 0.87% respectively.
Investors can also obtain leveraged exposure via the ProShares Ultra VIX Short-Term Futures (UVXY US) and the VelocityShares Daily 2x VIX Short Term ETN (TVIX US), which provide 1.5x and 2x daily leverage to futures based on the VIX index respectively. UVXY has AUM of $430m while TVIX has $530m. Both come with hefty price tags of 1.65%.
In Europe, the Lyxor S&P 500 VIX Futures Enhanced Roll (Lux) UCITS ETF (LVO NA) is one of the cheapest means of obtaining VIX exposure. It tracks the S&P 500 VIX Futures Enhanced Roll Index, a second-generation volatility index that dynamically switches between short-term VIX futures and mid-term VIX futures, based on their relative implied volatility, to order to enhance cost efficiency. Its total expense ratio (TER) is 0.60%.
Alternatively, the Boost S&P 500 VIX Short-Term Futures 2.25x Leverage Daily ETP (VIXL LN) offers 2.25x leveraged daily exposure to short-term VIX futures. Its TER is 0.99%.