Volatility Index Rock Bottom at 5 Year Lows

After bouncing off 5 year lows, VIX stalls at its 50 day moving average

VIX, the CBOE S&P 500 Volatility Index, also known as the “fear index,” recently hit 5 year lows, bounced off those lows and now has stalled at its widely watched 50 day moving average.

VIX ETNs Fall

VIX ETNs continue to fall even as VIX oscillates near recent lows.

One of the worst investments over the last few years has been iPath Short Term S&P 500 VIX ETN (NYSEARCA:VXX) which is off more than 90% since its 2009 highs.  The decline has been due to a combination of falling volatility and contango in which the new futures contracts going into the ETN are more expensive than the expiring ones and so the ETN experiences continual price decay. Some analysts are even forecasting that this ETN will soon undergo a reverse split.

Taking a look at the “big picture” for VIX, we see that the index recently made new lows not seen since 2007, then bounced slightly and is now stalled at its 50 day moving average.  It’s also below its 200 day moving average and the two indexes have formed what’s known as a “death cross,” a sell signal indicated by the 50 day moving average dropping below the 200 day average.

Why are VIX and VIX ETNs so weak?

Everyone has been trying to figure out why VIX and VIX ETNS like (NYSEARCA:VXX) and VelocityShares Daily 2X VIX ETN (NYSEARCA:TVIX) have been so weak.

Some experts believe that its due to lack of retail investor participation in markets while others believe that volatility now is completely driven by short term news events and that traders and investors are only active on days that contain market moving news.  According to an article in International Financing Review, “baseline volatility – the amount the market moves on an average, non-event day – has plummeted over the past four years….The median daily move for the S&P 500 index has dropped from over 1% in 2008 to just 0.4% so far this year, despite large daily moves occurring at a consistent rate over the last few years.”

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The VIX hit its five year low on August 17th and is averaging in the high teens this year compared to its normal average in the low to mid 20s.

Major VIX ETNs decline

Most major and the most popular VIX ETNs have experienced significant declines this year.

iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX): This ETN is designed to track volatility in the markets as measured by the Chicago Board Options Exchange Market Volatility Index (CBOE Index), a popular measure of the implied volatility of S&P 500 index options has declined from the $30s to mid $11/share so far for 2012.

VelocityShares Daily 2X VIX Short-Term ETN (NYSEARCA:TVIX): This ETN is designed to track 2X return on volatility in the markets as measured by the S&P 500 VIX Short-Term Futures Index and has declined from the mid $20s in January to the mid $2/share in late August, 2012.

iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ): This ETN is designed to track volatility in the markets as measured by the CBOE Volatility Index futures contracts.  The iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ) is priced from the average volatility of the 4th through 7th month futures contracts of the S&P 500 Index as traded on the CBOE and has declined from the mid $50s to mid $40/share so far in 2012.

S&P 500 Dynamic VIX ETF (NYSEARCA:XVZ): This ETN is designed to track volatility in the markets as measured by the S&P 500 Dynamic VIX Futures Total Return Index.  The S&P 500 Dynamic VIX Futures Total Return Index seeks to combine results of volatility of the S&P 500VIX Short-Term Futures Index Excess Return and the S&P 500 VIX Mid-Term Futures Index Excess Return to create an accurate market volatility reading, as measured by the CBOE.  The ETN is approximately flat year to date.

Velocity Shares Daily Inverse VIX Short-Term ETN (NYSEARCA:XIV): This ETN is designed to inversely track the volatility in the markets as measured by the S&P 500 VIX Short-Term Futures Index.  The S&P 500 VIX Short-Term Futures Index measures the volatility of the S&P 500 Index via futures contracts traded on the CBOE.  The CBOE Volatility Index is also known as the “fear” index or “fear” indicator in markets.  This ETN has climbed from the high $6/share to low $14/share range since January, 2012.

So it’s easy to see that, generally speaking, being long volatility and long VIX ETNs has been a losing trade for 2012.  Fundamentals point to the likelihood of low VIX ahead and technical indicators confirm a bear market in VIX and its related VIX ETNs.  VIX and VIX ETNs are definitely not suitable for buy and hold investments and require a proven trading strategy and good risk management in order to be successful in this tricky market.

Bottom line:  Overall, the most important factor likely driving VIX lower is the belief that the Federal Reserve will continue to be able to protect investors from declines in the equity markets.  This action will likely keep VIX at low levels since VIX tends to move inversely to equity prices. Keep a close eye on Jackson Hole and Dr. Bernanke’s speech on Friday for new factors influencing the price of VIX and VIX ETNs.

 

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John Nyaradi is the author of The ETF Investing Premium Newsletter.