{"id":121475,"date":"2022-01-28T12:59:00","date_gmt":"2022-01-28T17:59:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=121475"},"modified":"2023-02-10T13:31:50","modified_gmt":"2023-02-10T18:31:50","slug":"trading-volatility-is-difficult","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/options\/trading-volatility-is-difficult\/","title":{"rendered":"Trading Volatility Is Difficult"},"content":{"rendered":"\n<p class=\"wp-block-paragraph\">Which of these two would you rather hold?&nbsp; The following graph shows the normalized year-to-date performance of two very similar items.&nbsp; One is up over 29% in that time frame, which is a robust rise, but it pales in comparison to its counterpart, which is up over 72%.&nbsp; Let\u2019s take a look:<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-year-to-date-normalized-chart-of-two-items-to-be-revealed-later\"><strong>Year-to-date Normalized Chart of Two Items to Be Revealed Later<\/strong><\/h2>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"463\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-1100x463.png\" alt=\"Year-to-date Normalized Chart of Two Items to Be Revealed Later\" class=\"wp-image-121483 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-1100x463.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-700x295.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-300x126.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-768x324.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD-1536x647.png 1536w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-YTD.png 1918w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/463;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><em>Source: Bloomberg<\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">Obviously one would rather hold the item displayed by the green line.&nbsp; Who wouldn\u2019t want to hold something with more than double the return of the other?<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">The problem is that the green line shows the performance of the CBOE Volatility Index (VIX), which is not directly investable.&nbsp; There are VIX futures and options, but while they are actively traded products, none of them enable a trader to actually hold the index.&nbsp; VIX is not like the S&amp;P 500 Index (SPX) upon which it is based.&nbsp; One can buy the 500 stocks that comprise SPX in the proper ratios.&nbsp; Realistically, doing so is the exclusive province of institutional investors, but there is no shortage of index funds and ETFs that allow individual investors to own a small pro-rata slice of that portfolio.&nbsp;&nbsp; VIX is instead \u201c<a href=\"https:\/\/www.cboe.com\/tradable_products\/vix\/?gclid=464e346a1ca31c2df417559e3d86de8f&amp;gclsrc=3p.ds\">a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&amp;P 500\u00ae Index (SPX\u2120) call and put options<\/a>.\u201d&nbsp; In theory one could buy all the options with non-zero bids that make up the continually changing VIX calculation, but doing so is essentially infeasible.&nbsp; That is why investors use proxies like futures, options, and ETFs to gain exposure.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">A popular proxy is VIXY, the Pro-Shares VIX Short-Term Futures ETF, which is represented by the blue\/white candles in the graph above.&nbsp; My original gut instinct was to criticize the ETF itself for the underperformance.&nbsp; We have previously discussed the <a href=\"\/campus\/traders-insight\/securities\/crypto\/this-is-how-we-roll\/\">systematic underperformance<\/a> of an ETF that holds derivatives because those derivatives expire.&nbsp; Futures and options must be rolled prior to expiration, which has a slippage cost.&nbsp; More importantly, options decay, and a futures market that is in contango tends to see futures with longer expirations decline in value relative to the front contract.&nbsp; Yet in the case of VIX, if we want exposure to the underlying index we really don\u2019t have a choice about owning derivatives.&nbsp; The following graph shows that VIXY have tracked the futures rather well, actually:<\/p>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"year-to-date-normalized-chart-of-vix-green-vixy-blue-white-january-purple-and-february-red-vix-futures\"><strong>Year-to-date Normalized Chart of VIX (green), VIXY (blue\/white), January (purple) and February (red) VIX futures<\/strong><\/h2>\n\n\n\n<figure class=\"wp-block-image size-large\"><img decoding=\"async\" width=\"1100\" height=\"478\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-1100x478.png\" alt=\"Year-to-date Normalized Chart of VIX (green), VIXY (blue\/white), January (purple) and February (red) VIX futures\" class=\"wp-image-121482 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-1100x478.png 1100w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-700x304.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-300x130.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-768x334.png 768w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD-1536x668.png 1536w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2022\/01\/VIX-VIXY-Futures-YTD.png 1920w\" data-sizes=\"(max-width: 1100px) 100vw, 1100px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 1100px; aspect-ratio: 1100\/478;\" \/><\/figure>\n\n\n\n<p class=\"wp-block-paragraph\"><em>Source: Bloomberg<\/em><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">The inversion of the VIX curve has likely helped VIXY, because it allows them to replace near-month and near-week futures with longer-term counterparts that are trading at lower prices.&nbsp; That offsets the roll costs outlined in the article linked above.<\/p>\n\n\n\n<p class=\"wp-block-paragraph\">My aversion to derivative-linked ETFs is well-noted.&nbsp; I urge everyone who considers owning one to read the prospectus, particularly those that offer 2X, 3X or inverse performance.&nbsp; These instruments acknowledge that while they attempt to match the daily performance of their benchmark, they tend to systematically underperform.&nbsp; Here is an excerpt of the Proshares Trust II filing, which includes VIXY:<\/p>\n\n\n\n<p class=\"wp-block-paragraph\"><strong><em>\u201cTHE RETURN OF A GEARED FUND FOR A PERIOD LONGER THAN A SINGLE DAY IS THE RESULT OF ITS RETURN&nbsp;FOR EACH DAY COMPOUNDED OVER THE PERIOD AND USUALLY WILL DIFFER IN AMOUNT AND POSSIBLY EVEN&nbsp;DIRECTION FROM THE GEARED FUND\u2019S STATED MULTIPLE TIMES THE RETURN OF THE BENCHMARK FOR THE&nbsp;SAME PERIOD. THESE DIFFERENCES CAN BE SIGNIFICANT.\u201d<\/em><\/strong><\/p>\n\n\n\n<p class=\"wp-block-paragraph\">It is incumbent upon anyone investing in an ETF that uses derivatives to understand this concept.&nbsp; But if one wants to use a volatility-tracking ETF, they have little choice but to utilize this type of instrument.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>At first glance, a popular ETF seems to be badly trailing its benchmark. But the reality may be different.<\/p>\n","protected":false},"author":4,"featured_media":105699,"comment_status":"closed","ping_status":"open","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":"","jetpack_post_was_ever_published":false},"categories":[14,17,14700,6,19,8,9,22,26,3],"tags":[860],"contributors-categories":[13576],"class_list":["post-121475","post","type-post","status-publish","format-standard","has-post-thumbnail","category-etfs","category-futures","category-ibkr-market-insights","category-north-america","category-options","category-region","category-securities","category-stocks","category-text-articles","category-traders-insight","tag-volatility","contributors-categories-interactive-brokers"],"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v28.0) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>Trading Volatility Is Difficult | Traders&#039; Insight<\/title>\n<meta name=\"description\" content=\"At first glance, a popular ETF seems to be badly trailing its benchmark. 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