VIX ETFs Become Heavily Favored

The return of market volatility in October has once again reminded investors that risk and fear are part of the journey when investing in stocks. The SPDR S&P 500 ETF SPY has dropped more than 5 percent this month and is down more than 7 percent from its all-time closing high.

While that may not seem like a vicious drop to some, it has created a new dynamic on Wall Street that looks to capitalize on investor emotions.   

More specifically, exchange-traded products that track the CBOE VIX Volatility Index (VIX) have become popular destinations for traders looking to profit from this the unpredictability of stocks.

According to the CBOE website, the VIX “is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.”

Put simply, the VIX rises when fear ramps up in the markets and falls when complacency sets in. 

One of the most popular ways to play this trend is through the iPath S&P 500 VIX Short-Term Future ETN VXX, which provides exposure to near-term VIX futures contracts. 

VXX has more than $1.2 billion in total assets and charges an expense ratio of 0.89 percent.

Through the first half of October, VXX has risen 26.40 percent on the back of this equity and commodity sell off. However, it’s also worth noting that through the first nine months of the year, VXX lost more than 26 percent as stocks climbed steadily higher.  

This goes to show how quickly spurts of volatility can impact these fast-moving funds.

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For those that want to bet on a decline in volatility, the most popular vehicle is the VelocityShares Daily Inverse VIX Short Term ETN XIV. 

Since the beginning of October, XIV has seen net inflows of $524 million as traders switch from profiting on an expansion in volatility to betting on volatility contraction.

Ultimately, investors should be aware that there are a great many risks associated with aggressive funds of this nature. Double-digit percentage moves on a daily basis are not unusual in XIV and VXX.

In addition, these products are structured as exchange-traded notes, which mean they are debt instruments that promise to track an underlying index rather than a trust that directly owns underlying assets.