The stock market is a volatile place, and investors are constantly seeking ways to capitalize on the ups and downs of the market. One of the most popular ways to do this is through volatility trading. Two popular instruments that investors use to trade volatility are VIX and VXX. While they may sound similar, they are actually quite different. In this article, we will explore the differences between VIX and VXX and how they can be used to trade volatility.
What is VIX?
VIX, or the CBOE Volatility Index, is a measure of the market’s expectation of volatility over the next 30 days. It is calculated using the prices of options on the S&P 500 index. Specifically, it measures the implied volatility of S&P 500 index options. If investors expect the market to be more volatile, VIX will be higher, and if they expect it to be less volatile, it will be lower.
VIX is also known as the “fear index” because it tends to spike when there is a lot of uncertainty in the markets. For example, during the financial crisis of 2008, VIX reached all-time highs as investors panicked and sold off their stocks. Conversely, during periods of stability and economic growth, VIX tends to be lower.
What is VXX?
VXX, or the iPath Series B S&P 500 VIX Short-Term Futures ETN, is an exchange-traded note designed to track the performance of the S&P 500 VIX Short-Term Futures Index. In other words, VXX is an investment that allows investors to profit from short-term volatility in the market. It does this by investing in futures contracts on the VIX index.
VXX is designed to provide exposure to the volatility of the S&P 500 index, but it is not the same thing as VIX. VXX invests in futures contracts on the VIX index, which means that it is subject to the roll costs of the futures market. These costs can eat into the returns of the investment, especially if the futures are in contango.
Differences between VIX and VXX
The main difference between VIX and VXX is the way they are constructed. VIX is an index that measures the market’s expectation of volatility, while VXX is an exchange-traded note that tracks the performance of the futures market for the VIX index. VIX is a direct measure of volatility, while VXX provides exposure to volatility through the futures market.
Another key difference between VIX and VXX is the way they are traded. VIX is traded on the Chicago Board Options Exchange, while VXX is traded on the NYSE Arca exchange. VIX is a cash-settled index, which means that it can only be settled in cash. VXX, on the other hand, is an exchange-traded note, which means that it can be settled in shares or in cash.
VXX is also subject to the roll costs of the futures market, which can impact its returns. Roll costs occur when futures contracts are rolled over into new contracts. This can be a problem if the futures are in contango, which means that longer-dated contracts are more expensive than shorter-dated contracts. This can result in a negative roll yield, which can eat into the returns of the investment.
How to trade VIX and VXX
Trading VIX and VXX can be done through the use of options, futures, or ETFs.
Options: Investors can buy or sell options on VIX or VXX to take a view on volatility. Options give investors the right, but not the obligation, to buy or sell a security at a certain price (the strike price) within a certain time period (the expiration date). Option contracts on VIX or VXX have a value that is linked to the price of the underlying index. Buying a call option on VIX or VXX is a bullish bet on volatility, while buying a put option is a bearish bet.
Futures: Investors can also trade VIX or VXX futures contracts. Futures contracts are agreements to buy or sell an asset at a predetermined price and date in the future. Futures contracts on VIX or VXX are settled in cash based on the value of the underlying index at the expiration date. Futures contracts can be used to take a directional view on volatility or to hedge against volatility.
ETFs: Finally, investors can trade ETFs that provide exposure to VIX or VXX. These ETFs can be bought and sold like stocks and provide investors with exposure to the underlying index without the need for options or futures. Some popular VIX and VXX ETFs include the ProShares VIX Short-Term Futures ETF (VIXY) and the Barclays iPath S&P 500 VIX Short-Term Futures ETN (VXXB).
FAQs
Q. What is the difference between VIX and VXX?
A. VIX is an index that measures the market’s expectation of volatility, while VXX is an exchange-traded note that tracks the performance of the futures market for the VIX index.
Q. How do I trade VIX and VXX?
A. You can trade VIX and VXX through the use of options, futures, or ETFs.
Q. Can VIX or VXX be used to hedge against market volatility?
A. Yes, investors can use VIX or VXX to hedge against market volatility. They can also be used to take a directional view on volatility.
Conclusion
In conclusion, VIX and VXX are both important tools for trading volatility in the stock market. While they may sound similar, they are actually quite different. VIX is an index that measures the market’s expectation of volatility, while VXX is an exchange-traded note that tracks the performance of the futures market for the VIX index. Understanding the differences between these instruments is important for investors who want to profit from volatility or hedge against it.