Volatility ETFs Are Ridiculously Bad

7 Ağu

When market volatility spikes, I see many traders start talking about volatility instruments like UVXY, VXX, and UVIX. Yes, in the moment, these symbols may spike a bit, but over the long-term, and as clearly shown on the chart above, they appear to do only one thing – go down. So, I am writing this post to try to help any traders/investors out there interested in these instruments.

First of all, to new traders, these instruments like an easy way to go long on volatility – “I don’t have to trade options? I can just buy this ETF? I’m in!” However, I am surprised these instruments are legal given how they are branded. Consider this: the UVXY ETF has gone from $300 million per share to $40 per share at the time of this writing.

Yes, read that again. Had you invested $300 million into this volatility instrument at its inception a little more than 10 years ago, you would have $40 today.

How are these ETFs even legal? How can they be positioned like this? Countless people must get tricked by them.

In this post, I will explore popular volatility ETFs and ETNs with some basic concepts to help traders and investors looking to learn more. Seven years ago, I wrote one of my most popular posts ever directly related to this topic titled, "How To Avoid Bad ETFs and ETNs."

2. Beta Decay: This concept may sound complicated, but the following mathematical example will open your eyes. These instruments are subject to daily rebalancing, leading to a compounding effect. For example, if an ETF loses 5% one day and gains 5% the next day, it doesn’t return to its original value. Starting at $100, a 5% loss takes it to $95, and a 5% gain brings it only up to $99.75, not $100. Do this over and over, and it just keeps going down.

2. Contango: It took me a long time to understand this term, but essentially, it works like this: when the VIX futures market is in contango (where longer-term futures are priced higher than near-term futures), these ETFs suffer from the cost of rolling futures contracts. This erosion occurs as funds must continually buy higher-priced longer-term contracts while selling lower-priced near-term contracts.

3. Volatility Drag: Some VIX ETFs are labeled as “2x Volatility” or “3x Volatility,” meaning these ETFs must adjust their futures holdings daily, buying in rising markets and selling in declining ones. This results in what is known as volatility drag, which can cause losses over time.

Anyways, that's it! It's crucial that we share these stats and facts to help unsuspecting traders and investors understand that these tools are not like traditional stocks. This is why I write so much about this topic and will continue to do so.

Disclaimer: As always, I ONLY share for my own entertainment and education. Nothing else. The point of this post is rather simple – one of the greatest money schemes in Wall Street history is selling new investors and traders “Volatility ETFs.”

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