(ETN) High Anxiety

When you see a bad deal in the stock market, there’s usually a way to take the other side of that trade and reap the rewards the other party gives up.

With the markets stumbling this year and fear running high, many investors are looking for a way to profit from the anxiety. After all, it’s always nice to own something that spikes higher while other investments are falling.

The market’s most well-known “fear gauge” is the CBOE Volatility Index, a.k.a. the VIX. When fear hits the stock market, the VIX surges.

But because the VIX is an index, it’s not directly tradable.

There’s a way to trade the VIX in the futures market, but it has a big drawback. Futures contracts have expiration dates. The contracts with nearer expiration dates are usually cheaper.

That’s why rather than try to play the VIX directly, many investors turn to an exchange-traded note (ETN).

The popular iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) can be used for short-term trades but will crush you over longer time frames.

I’ll explain…

To create the VXX, iPath constantly rolls VIX futures contracts forward. It must sell out of the contracts that are set to expire and then purchase next month’s futures contract.

They lose a bit of money with almost every roll. That effect, the result of something called “contango,” directly hits VXX.

Just look at the chart below, comparing the VIX to the VXX. It begins in the summer of 2011 when investor confidence was high and the VIX was low. Later that summer, the S&P 500 declined by 19%, as S&P downgraded the U.S. credit rating for the first time.

But as the months passed, the VIX and the VXX both declined again.

Then why is it so popular? Probably because people are using it as a short-term hedge against sharp market declines and don’t know how else to do it.

What most investors don’t realize is there is an ETN that does the exact opposite of what VXX does. VelocityShares Daily Inverse VIX (NYSE: XIV) makes money when VXX loses money.

Below is a chart comparing the VIX to the XIV in the same time frame as the chart above. Remember, XIV is the opposite of VXX so it declines when fear hits the market. But the opposite is also true: As the market charges higher, so does the XIV.

And over the long haul, the market almost always charges higher.


Keep in mind XIV is approximately three to four times more volatile than the S&P 500. If you buy it at the wrong time it can get ugly, and I don’t want to encourage anyone to overleverage.

Notice how it declined 74% during the mini-crash of 2011. Even in the recent correction last month it declined 30% in just two weeks.

Of course, from the 2011 low to last month’s high, it advanced over 620%.

The way to play XIV is to buy it when you think the market has hit a bottom. I’ll leave it up to you to decide what time frame to play.

Bottom line… if you’re looking to take advantage of the market’s recent volatility, you’ve got a fresh idea worth exploring.

Good investing,

Chris

P.S. I want to hear how you’re playing this market. Please feel free to leave comments below.


View original at: Investment U

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