Alternative ETFs: Understanding VIX ETFs

The Chicago Board Options Exchange Volatility Index (VIX index) attracts traders and investors because it often spikes way up when US equity markets plunge. Known as the fear gauge, the VIX index reflects the market's short-term outlook for stock price volatility as derived from options prices on the S&P 500.

The challenge is that investors just can't access the VIX index. Period.

VIX ETFs exist, but they actually track VIX futures indexes, which creates 2 big challenges:

  1. VIX ETFs don't reflect the VIX index By any measure, VIX futures indexes—and therefore VIX ETFs—do a lousy job emulating the VIX index. The VIX index is truly uninvestable, and over periods of a month or a year, the return pattern of VIX ETFs will differ radically from that of the VIX index.
  2. VIX ETFs tend to lose money—significant money—in the long run VIX ETFs are at the mercy of the VIX futures curve, which they rely upon for their exposure. Because the typical state of the curve is upsloping (in contango), VIX ETFs see their positions decay over time. Decay in their exposure leaves them with less money to roll into the next futures contract when the current one expires. The process then repeats itself, leading to massive double-digit losses over the course of a typical year. These funds almost always lose money long term.

In it for a minute

In the real world, traders stay in VIX ETFs for 1 day, not 1 year. VIX ETFs are emphatically short-term tactical tools used by traders. Products like , an exchange-traded note (ETN), are incredibly liquid, often trading more than their total assets under management, or AUM, in 1 or 2 days of trading. Traders speculate with VIX ETFs because they offer the best (or least-worst) means to get at the VIX index in the very short run. So-called "short-term" VIX ETFs offer better 1-day sensitivity to the VIX index then do "midterm" VIX ETFs.

It's a wrap

VIX ETFs aren't ETFs in the strictest sense. They come in ETN or commodity pool structures, not as traditional mutual funds. ETNs carry the counterparty risk (usually low) of the issuing banks, while commodity pools issue K-1's at tax time.

VIX ETFs come in other flavors than the pure-play described above. VIX overlay ETFs hold broad equity positions and an overlay of VIX futures exposure. They aim to limit downside equity risk but either bear or try to minimize the high cost of long-term VIX futures exposure.

So in conclusion, if you're looking to get exposure to VIX for a couple of days, there are products out there for you, but perhaps more than any other corner of the ETF market—buyer beware!

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Article copyright 2014-2023 by Reprinted with permission from The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.

ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses.

Exchange traded products (ETPs) that offer exposure to stock market volatility (“Volatility ETPs”) entail significant risk and are intended for very experienced, aggressive, sophisticated investors who actively manage their investments daily. Volatility ETPs are intended for short-term trading and should not be used as a buy and hold investment. Volatility ETPs should not be expected to appreciate over extended time periods.

The CBOE Volatility Index (VIX) is a measure of the expected or implied volatility of the S&P 500 index. Direct investment in the VIX is not possible; therefore, Volatility ETPs gain exposure to market volatility through futures and/or options contracts on the VIX. Therefore, a Volatility ETP’s return may not match the actual daily VIX fluctuations, as it is determined by the changes in the market’s expectation of future volatility. As a result, the performance of Volatility ETP’s may be significantly different than the performance of the VIX, the benchmark VIX futures index, and actual realized volatility of the S&P 500 Index. VIX futures contracts are among the most volatile segments of all futures markets. Volatility ETPs may be subject to extreme volatility and greater risk of loss than other traditional exchange traded funds which offer returns based on broad asset categories. The tax treatment of Volatility ETPs may vary. There are no guarantees that any Volatility ETP will achieve its stated objective. Please read the prospectus carefully to make sure volatility ETPs are right for you and that you understand their unique features, risks, fees and tax treatment. 718469.3.1