Volatility ETFs Advance On Rising Yields

After the best start in many years for Wall Street, equities pulled back with the Dow and the S&P 500 indexes marking their biggest one-day declines in about five months.

Meanwhile, the CBOE Volatility Index (VIX), also known as the fear gauge, jumped 26.5% to $14.02 -- its highest close since Aug 18. This suggests that market fears have started to set in. The fear gauge measures investors' perception of the market's risks and tends to rise when stock falls or investor panic starts to set in.

The appeal for equities seems diminishing on rising borrowing cost, which could put a halt to the bull market drawing close to nine years. Notably, the 10-year Treasury yields rose to its highest level since April 2014 on the prospect of global monetary tightening following the European Central Bank (ECB) intention to end its bond purchases this year.

Additionally, the recent rally has triggered fears of overvaluation in an aging bull market. According to Jim Paulsen, chief investment strategist at Leuthold Group, "For the first time in this recovery, the stock market has finally become expensive based on its ‘new valuation range,'" referring to record-high price-to-earnings multiple (read: Is Government Shutdown a Bull Market Threat? ETFs in Focus).

ETF Impact

Given this, volatility ETFs jumped on the day with Rex Volmaxx Long Vix Weekly Futures Strategy ETF VMAX climbing the most by 8.4%. It provides long exposure to the VIX Index by holding a combination of VIX futures contracts that are near expiration. It has amassed $2.8 million in AUM and charges 2.90% in fees per year. It sees a meager volume of about 7,000 shares a day.

VelocityShares Daily Long VIX Short-Term ETN VIIX gained 7.4%. This ETN follows the S&P 500 VIX Short-Term Futures Index, which reflects implied volatility of the S&P 500 Index at various points along the volatility forward curve. It provides investors with exposure to a daily rolling long position in the first and second month VIX futures contracts. VIIX is unpopular, having just $9.8 million in its asset base, and sees moderate volume of 109,000 shares per day. The ETN charges 89 bps in annual fees.

ProShares VIX Short-Term Futures ETF VIXY was up 7.3%. This fund also allows investors to capitalize on the U.S. equity market volatility one month into the future by tracking the S&P 500 VIX Short-Term Futures Index. The product has $140.2 million in AUM and sees heavy average daily volume of 1.4 million shares. The ETF charges 0.85% in expense ratio.

iPath S&P 500 VIX Short-Term Futures ETN VXX also gained 7.3%. This ETN follows the S&P 500 VIX Short-Term Futures Index and is the most popular and liquid option in the volatility space. The note has amassed $933.6 million in AUM and charges 89 bps in annual fees and expenses. The product sees a truly impressive volume level of more than 32.4 million shares a day (read: Top & Flop ETFs of the New Year).

Leveraged ETFs, ProShares Ultra VIX Short-Term Futures ETF UVXY and VelocityShares Daily 2x VIX Short-Term ETN TVIX, which offer two times (2x or 200%) to the S&P 500 VIX Short-Term Futures Index, gained 14.2% on the day.

Out of the two, UVXY is more popular with AUM of $354.6 million and average daily volume of about 28.3 million shares. Further, it charges a lower fee of 95 bps compared with 1.65% for TVIX.

Bottom Line

Investors should note that these products are suitable only for short-term traders. This is because most of the time, the VIX futures market trades in a condition known as contango, a situation where near-term futures are cheaper than long-term futures contracts. Since volatility ETFs and ETNs like VXX must roll from month to month in order to avoid delivery, the situation of contango can eat away returns over long periods (see: all the Volatility ETFs here).

However, though volatility of volatility is pretty high, this seems a good time to remain invested in this market.

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