VSXX Disappoints European Investors

I have written before about VSXX - an ETF that tracks pan-european VSTOXX volatility index, European equivalent of VXX. In that post I described how VSXX performance may be different, because of the flatter term structure of VSTOXX volatility futures, that will translate into lower rolling costs, and better performance for VSXX investors, at least compared with VXX. I also noted that traders may take advantage of this difference in a relative value trade. When I wrote the post, VSXX was trading for only two months, however now after seven month of trading it is becoming clear that my investment hypothesis not deliver, and VSTOXX futures markets became more economically efficient.

Here's the chart of what happened: VSXX originally listed at around the same Euro value as the index, however in the last few weeks VSXX is about 70% of VSTOXX index.



If you looked at the relative plots of VIX and VSTOXX with their futures indexes (on which ETFs are based) it is clear that historically VSTOXX futures index did much better job in tracking index levels than the VIX futures index. To understand the dynamics, I have performed the following two regressions:

return on SPVIXSTR ~ α + β * return on VIX, and
return on VST1MT ~ α + β * return on VSTOXX.

Using the data for the last five years, in the first case α = -0.0016174 (t=-3.2335) α * 252 = -40% per year negative "premium" for the VIX futures index. In the second case α = -0.00021095 (t= -0.30876, intercept not statistically significant) α * 252 = -5% per year negative "premium" for the VSTOXX futures index.

However when I used data for the last half year - approximately since VSXX came into existence, intercept values became much closer to each other, at -0.006422 -0.0047229 for VIX and VSTOXX respectively. These numbers by themselves imply a very negative risk premium, they are at least the same order of magnitude, as opposed to alphas from the 5-year regressions.

It seems that there is an equal demand now in Europe for volatility protection, which brought returns on the futures indexes in line with each other. In fact VSXX and VXX followed very similar paths (normalized returns in local currencies)

In conclusion: what was hoped to be a unique investment opportunity for European investors seized to exist. Once a trading instrument is in the market traders work quickly to make profits and eliminate inefficiencies.

Understanding VIX Futures Movement, Part 2

Part 1 here, part 3 here. Everyone knows that VIX futures (and ETFs) do not move one to one with the index. Given the complicated dynamics of the index - jumps, multiple regimes, mean-reversion - it is actually not surprising that replicating the index in a tradable instrument is not trivial. However there's very little info about quantifying the relationship.

In this excellent article surlytrader talks about imperfect correlation between VIX futures and the index, writing "... VIX futures become less correlated to the spot VIX index as you move further out in expirations. ... By investing further out on the curve, we do not capture as much of the movements of the VIX spot index. On the flip side, by investing further out on the curve, we lose less as the futures contract ages." Surlytrader also provides a plot with schematic depiction of correlation declining with time to maturity. In the plot he calls it VIX Beta, but I thought that VIX Delta would be more in line with the convention.

To explain the relationship I created an applet that quantifies and illustrates this dynamic relationship between futures prices, tenor, and correlation to the index. One of the most intuitive features is the effect of mean-reversion parameter on the price and delta. When mean reversion is large VIX futures converge quickly to their long-term level, and delta quickly decays toward 0. When mean-reversion is small (e.g. like it is in the stock market) then more familiar dynamics emerge - futures are "connected" to the index level, and correlation is high.



If you do not see the applet above you may need to download shockwave player from Adobe (same company that makes Flash player, and Pdf reader)

One of the practical applications of VIX futures delta is trading calendar spreads on VIX futures /options / ETFs, and measuring position risk.