Over the past decade, few ETFs have been as hated (or really, really hated and occasionally loved) as the VXX Volatility ETN. After the spectacular implosion of the inverse VIX ETN/ETF universe in February's 5-sigma VIXtermination event...
...the VXX emerged as the largest VIX exchange-traded product (ETP). However, it is far more memorable for the fact that since its inception ten years ago, VXX shares have lost over 99.9% of their value during the past ten years, with the current $40.11 share price corresponds to an initial price of $102,400 at initiation in 2009 (adjusting the initial $100 price for 1:4 splits in 2010, 2012, 2013, 2016, and 2017).
Yet while discouraging, Goldman's derivatives strategist Rocky Fishman writes that this strong negative performance needs to be viewed in the context of historically unfavorable conditions. Since the VXX was launched, the SPX has more than tripled, and volatility has fallen relentlessly, with 3-month SPX realized volatility lower than it had been in the previous 3 months 62% of the time – the highest frequency since the 1940’s. This led to steep volatility curves in much the last 10 years and a high cost of protection, which the subsequent downside failed to justify. Meanwhile, in moments of severe volatility the VXX has been a powerful hedge... one just had to time then.
What is more notable, is that 2018 is on pace to become the VXX’s first up-year, with its share price up 45% year-to-date. The SPVXSP, the index behind the VXX, had substantial full-year gains in 2008 and 2007 as well. On a shorter-horizon basis, the VXX share price doubled in each of the major volatility spikes of 2010, 2011, 2015, and 2018.
Yet all of the above will soon be moot: next month the VXX will cease to exist, because as Goldman reminds us this morning, next month, the VXX will finally be laid to rest when it reaches its long-scheduled maturity date.
To commemorate the VIX's imminent passing, the Goldman strategist fondly remembers its "hedging" abilities, writing that "even though the VXX has had strongly negative returns over its 10-year life, most of which was a historic S&P 500 bull market, this year has become another reminder of how powerful long volatility can be as a hedge."
More to the point, Fishman has published a Q&A which addresses next month’s maturity event, current ETP positioning, and the economics of unlevered long VIX ETPs.
Below we excerpt and highlights the key points from what will, in just a few weeks, be literally a VXX post-mortem.
1. What is happening to the VXX in January? Will the VXX continue to exist following the end of January?
The largest and oldest VIX ETP, the VXX (iPath S&P 500 VIX Short-Term Futures ETN), will reach its final valuation date toward the end of next month, on January 29. The VXX currently has $850mm of AUM, representing around 40mm vega ($40mm per VIX futures point). Holders of the VXX on the final valuation date will receive a cash payment from the issuer equivalent to its NAV on that date, and subsequently the VXX will cease to exist. The same will happen with the smaller VXZ, which is similar to the VXX, but is based on the 4th through 7th listed monthly VIX futures, in contrast to the VXX’s exposure to the 1st and 2nd VIX futures.
2. Why does the VXX have a maturity date?
Exchange-traded notes (ETNs) are essentially debt instruments, and similar to other debt, they carry a fixed maturity date upon which security holders will receive a payment (in this case based on a formula that uses VIX futures prices). This contrasts with exchange-traded funds (ETFs) which are portfolios that hold assets, and can continue to exist indefinitely. Investors should expect to receive a cash payment equal to the final NAV for each share ($39.70 as of today). At this current price, it represents a return of -99.9% for investors that bought VXX shares at their initiation in 2009. An investment of $100 in 2009 would have declined to 4 cents after adjusting for five 1:4 splits.
3. What can investors do with existing VXX shares?
iPath’s VXXB ETN (launched earlier this year as a replacement for the VXX) and ProShares’s VIXY ETF both have nearly identical economics to the VXX. We expect that investors will replace VXX shares with one of these prior to 29-Jan. We discuss pros and cons of the two alternative products below. For the largest investors, redeeming VXX shares and creating VXXB shares at NAV on the same day may be an efficient way to avoid slippage while rolling this exposure, because the two transactions would both take place at their shared NAV.
4. What is the impact of the VXX maturity on VXX options?
The VXX maturity has prevented options from being listed with expirations beyond the 29-Jan final valuation date. The 18-Jan-2019 LEAP expiration has the largest open interest of current VXX expiries, and there is also a 25-Jan weekly expiration. We do not expect any impact of the maturity on these expirations. Historically, there had been strong interest in long-dated VXX options, with next month’s Jan-2019 expiration already showing $500mm of notional open interest a year ago (13 months before expiration). We expect growth in the VXXB and/or VIXY to lead to a return of long-dated options activity (the VXXB and VIXY both have listed options, but open interest in each is <3% of the VXX’s even after quick recent growth in VXXB options activity). Long-dated options on unlevered long VIX ETPs, essentially a risk-limited form of exposure to a volatility trading strategy, are useful as a short vol trade (puts) and as a convex protection strategy (calls).
5. Does the VXX’s maturity present any market risks?
The biggest risk raised by the maturity is that a sizable group of holders (or short positions, which currently represent nearly 200% of shares outstanding) do not roll their positions, leaving the issuer with a large long vega position to unwind on the final valuation date. We do not expect this to happen, as we expect investors to roll their positions to other products as we approach the maturity date. The 19-Jan options expiration is a key moment to watch, as holdings that are linked to option positions may be unwound simultaneously with the options’ expiring. Between now and 29-Jan, the VXX’s no-arbitrage mechanism, based on the facility to exchange shares for NAV, should continue to limit the potential for the note to experience material dislocations.
Current VIX ETP positioning
6. Have investors rolled their existing VXX positions to VXXB shares?
They mostly have not. The VXX currently has more than 4 times the AUM of the VXXB, and represents over 70% of the AUM of US-listed, unlevered long VIX ETPs
7. What are the largest VIX ETPs, and how do they compare with each other?
The soon-to-expire VXX is the largest VIX ETP in AUM terms, by a significant margin, though the levered-long TVIX has the largest vega exposure. The 1.5x levered long UVXY, and the largest remaining short ETP, the SVXY, are the next-largest. The US-listed unlevered long VXXB and VIXY both have over $100mm AUM, as do the Taiwan-listed 00677U and Japan-listed 1552. There continues to be a group of additional VIX ETPs that have smaller amounts of AUM.
The VXXB ETN and VIXY ETF each have almost identical economics to the VXX. The VXXB is, by design, nearly identical to the VXX. Its initial share price was set to be exactly the same as the VXX’s NAV on the same date, so the two products have identical NAVs every day of their overlapping lives. Small differences include a longer maturity (30 years for the VXXB vs. 10 years for the VXX) and an issuer call option (with at least 5 days’ notice before an accelerated final valuation date is reached) in the VXXB that exists in other iPath ETNs. With neither the VXXB nor VIXY showing VXX-like liquidity at the moment, institutional investors will be watching the liquidity of each to see where to allocate post-VXX assets. The VXXB already has more AUM and a larger option market than the VIXY, but the slightly lower fees and lack of credit risk may make the VIXY a more attractive VXX substitute for longer-term holdings.
8. Why has the VXX often had more inflows than the VXXB and VIXY in recent months? Is that irrational?
The VXX is often held for very short periods, so for many VXX holders, the two-month maturity may be much longer than their expected holding period. At the moment, we see the VXX as substantially more liquid than the VXXB and VIXY, both in terms of tighter bid/ask spreads and in its larger options market. Investors seeking to trade in and out of positions quickly should rationally be more focused on transaction costs than on time to maturity. The potential for AUM growth in the VXXB and VIXY could drive stronger liquidity in one or both of them as we approach the VXX’s late-January maturity date.
There also may be sizable VXX positions held as part of options strategies that could disappear or be unwound after the options expire; notional open interest on the 19-Jan VXX options expiration is more than seven times the size of the VXX itself.
9. How has net VIX ETP positioning changed since February’s VIX spike?
The complex as a whole holds a large net long vega position. The current position is similar to several years ago, after reaching a net negative position in early 2018. Prior to February’s VIX spike, inverse VIX ETPs represented the majority of AUM, but the spike itself destroyed most of the inverse products’ market value and caused the XIV and two smaller ETPs to be redeemed. Subsequent to February, the one remaining short-dated short VIX futures ETP, ProShares’s SVXY, has seen net outflows in addition to its share price decline.
Economics of the VXX
10. How did the VXX perform during its 10-year history?
VXX shares have lost over 99.9% of their value during the past ten years; however, in moments of severe volatility the VXX has been a powerful hedge. The current $40.11 share price corresponds to an initial price of $102,400 at initiation in 2009 (adjusting the initial $100 price for 1:4 splits in 2010, 2012, 2013, 2016, and 2017). While discouraging, this strong negative performance needs to be viewed in the context of historically unfavorable conditions. Since the VXX was launched, the SPX has more than tripled, and volatility has fallen relentlessly, with 3-month SPX realized volatility lower than it had been in the previous 3 months 62% of the time – the highest frequency since the 1940’s. This led to steep volatility curves in much the last 10 years and a high cost of protection, which the subsequent downside failed to justify.
It is notable, though, that 2018 is on pace to become the VXX’s first up-year, with its share price up 45% year-to-date. The SPVXSP, the index behind the VXX, had substantial full-year gains in 2008 and 2007 as well. On a shorter-horizon basis, the VXX share price doubled in each of the major volatility spikes of 2010, 2011, 2015, and 2018. As discussed below, the VXX’s performance is a function of the change in volatility level, and the cost of futures rolling down the usually upward-sloping VIX futures curve. This year, the roll-down effect has been milder (2%/month on average) than in any year since 2008, and the level of VIX futures has risen more than in any year since 2008 (80% increase from 11.9 at the end of 2017 to 21.3 now).
11. Why does the VXX’s performance differ from the VIX’s performance?
Owning the VXX is different economically from owning the VIX. The VXX and other VIX ETPs are linked to VIX futures, not the untradeable spot VIX index itself. Additionally, the VXX’s returns are not simply the change in the weighted average VIX futures level, because the product’s index is changing its portfolio of VIX futures on a daily basis.
The performance of the VXX and other unlevered long ETPs is a function of two components: the change in the level of volatility and the aggregate roll cost (or benefit) of moving along the VIX futures curve. The equations below show this exact relationship on a one-day basis and an approximation of how to estimate this over longer-periods. Over short periods of time, the change in vol level has the potential to be stronger, and over the long run, the continuously-compounding roll effect tends to dominate the mean-reverting vol level.