VXX And VIX Explained: Understanding Volatility
When it comes to investments, not everyone has the same appetite for risk. Some investors are very conservative with their money and will only invest in assets that have low volatility. Others are more aggressive and will take on higher-risk investments to get a bigger return.
The VXX and VIX are two tools used by traders who want high returns but also need protection against wild fluctuations in the market.
What Is VXX?
VXX is a short-term exchange-traded note (ETN) designed to track the VIX Short Term Futures Index. Barclays Bank launched it in 2009. Currently, VXX has a market cap of nearly $900 million. The only way for investors to buy or sell a share of this fund is on the NYSE Arca stock exchange via an online brokerage or account.
What Is VIX?
The Volatility Index, or VIX for short, was created by the Chicago Board Options Exchange (CBOE) in 1993. The VIX gives traders an idea of how volatile the stock market has been over a period so they can determine whether it’s a good time to buy and sell different assets.
Investors also use it to determine how much they should be paid for taking on risks in their portfolios. VIX is closely related to the S&P 500 index, which tracks the performance of 500 large companies that represent about 80% of all market cap value in public US markets.
According to tastytrade, “the VXX is an Exchange Traded Note (ETN) that tracks the VIX short-term futures. To be more specific, the VXX is a portfolio composed of the front two-month /VX futures that bear continuously changing weights.”
The Differences
When comparing VXX vs VIX, the differences can be outlined based on:
Calculation
The underlying index for both tools is the same. However, they are calculated differently. VIX is calculated from SPX options data. It is published every 15 seconds as an estimate of expected volatility over the next 30 days.
On the other hand, VXX is calculated by using the front two VIX contracts that expire in one month and then rolling them into a new futures contract that expires the next month.
Use
The primary use of VXX is to hedge your equity portfolio against a significant drop in the market. This tool’s performance will mirror that of the volatility index. Meaning it can be used as an alternative to shorting S&P 500 or putting money into cash.
It is easy to buy and sell shares of VXX through most online brokerages, so both beginners and advanced traders alike can use it.
The usefulness of the volatility index (VIX) in trading will depend on how you apply it. For example, if your goal is to bet against a crash in the market (a process known as “shorting”), this tool can help determine when to enter and exit trades. However, if you are looking for a way to protect your investments against drops in the market, then VXX is probably more suited to this purpose.
One benefit of the VIX is that it calculates short-term historical volatility and uses this data as an indicator. Such calculations make it easier to predict whether or not stocks will rise or fall over the next 30 days. The other advantage is that the VIX can create a diversified portfolio since it covers many different assets.
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