Of life's many fields of endeavor, financial markets are among the most fertile grounds for the flawed logic that the longer something behaves in a particular way, the more likely it is that the trend will reverse.
That is interesting because financial markets also brought us the logic that something can stay irrational longer than we can stay solvent. Before getting too wrapped up in cliches and sayings, the cold, hard truth is traders continue pouring capital into arguably one of the worst inventions in the history of U.S. markets: Long volatility exchange-traded notes (ETNs).
Focusing on the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) and the ProShares Ultra VIX Short-Term Futures ETF (NYSE: UVXY), traders are fond of these products. That despite the fact that volatility ETNs have a long-standing reputation as destroyers of value.
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“Regardless, in early trading today we see more new highs in major equity indices, and corresponding new all-time lows in Long Volatility linked products like VXX and UVXY,” said Street One Financial Vice President Paul Weisbruch in a note out Monday. “VXX for example is trading with a $17 (split-adjusted) handle for the first time ever today, as a combination of weak VIX prices and futures market contango continue to doom these products.”
VXX tracks the S&P 500 VIX Short-Term Futures Index, which “is designed to provide access to equity market volatility through CBOE Volatility Index,” according to iPath.
The thing is that is a futures-based index, meaning traders indulging VIX ETNs can potentially be exposed to contango. Contango is the scenario where the price of a commodity is above the future spot price and, as highlighted by longer running returns, can have dangerous implications for UVXY and VXX.
Highlighting the dangerous combination of leverage and contango potential for anyone opting to hold UVXY longer than a day or two, that ETN is down 38.3 percent over the past month and has lost more than 98 percent over the past three years. VXX is no peach, either, with a three-year slide of almost 85 percent.
Yet, there's over $1 billion sitting in VXX, more than 23 percent of which has arrived just this year. On year-to-date basis, UVXY and VXX have combined inflows of $335 million while being down an average of 45.5 percent.
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