Trading the VIX – Part 2

Trading the VIX – Part 2: VIX ETPs and Strategic Applications

In Part 1 of this series, we explored the structure of VIX Futures, focusing on the roll-down effect in a contango VIX futures curve—common in calm market conditions.
In Part 2, we turn our attention to VIX-related Exchange-Traded Products (ETPs)—specifically, the popular and liquid:

• VXX – unleveraged long VIX ETP
• UVXY – leveraged long VIX ETP
• SVXY – inverse VIX ETP

Each of these products is based on a specific VIX futures strategy, the “S&P500 VIX Short Term Futures Index”, which is maintained by S&P, Dow Jones (the “SPDJ-Index”). The Fact Sheet and Methodology can be obtained from the S&P Global website.

What is the SPDJ Index that these ETPs track?

The SPDJ-Index is a strategy index that maintains a rolling long position in the first- and second-month VIX futures to maintain a constant 30-day weighted average maturity.

Key Features of the SPDJ Index:

• Starts with 100% exposure to VX1 (the front-month future) when it’s 30 days from expiration.
• Gradually it rolls from VX1 to VX2 (next-month future) each day to maintain a 30-day average expiration.
• At all times, the index is long either one or both VX1 and VX2, with exposure shifting daily from VX1 to VX2.
• This roll mechanism causes value erosion in contango (normal markets) and gains in backwardation (during volatility spikes).
• Since contango is the dominant market state, the index loses value over time—with occasional short-lived gains during sharp volatility increases.

Importantly, the SPDJ Index does not represent the VIX or any other volatility level, it simply reflects the value of this futures-based rolling strategy.
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Breakdown of the ETPs: VXX, UVXY, and SVXY

VXX – Long SPDJ Index (1x)

• Tracks the SPDJ Index directly
• Suffers from the roll-down drag in contango environments.
• Useful only for short-term exposure during expected volatility spikes.
• Timing for long positions is critical

UVXY – Leveraged Long (Currently +1.5x)

• Replicates a strategy that maintains a constant leverage of 1.5 to the SPDJ Index.
• Formerly +2x leverage; reduced in April 2024.
• Highly sensitive to VIX moves; underperforms long term due to both roll-down drag and leverage decay (see below). Timing for long positions is even more important than for the VXX.

SVXY – Inverse (-0.5x)

• Replicates a strategy that maintains a constant exposure of -0.5 to the SPDJ Index.
• Benefits from falling VIX levels as well as from contango in the front part of the VIX futures curve.
• Formerly -1x before the Feb 2018 volatility spike triggered massive losses (XIV, a competing ETP, collapsed at that time).
• Performs well in calm conditions but is vulnerable to sharp volatility spikes.

Leveraged & Inverse ETPs – Important Notes affecting the UVXY and SVXY (without going into details):

• Daily resetting for the replicating strategies to maintain constant exposure factors (different from 1x) are pro-cyclical and can cause compounding errors, specifically in turbulent markets (e.g. Feb 2018).
• The real volatility of the VIX futures itself acts as a drag on returns, independent of the index’s direction.
• Risk management is essential—especially with inverse products like SVXY.

All three of these ETPs track a VIX futures strategy, they are not levered or unlevered versions of the original VIX index. Each of these ETPs benefits from liquid option markets, enhancing the toolkit for volatility trading.

Trading Strategies Using VIX ETPs
Here are several practical approaches to trading these products:

VXX and UVXY

• Best used for short-term trades aiming to capture volatility spikes.
• Options strategies such as zero-cost collars, vertical and calendar spreads can help mitigate the challenge of precise timing.
• Avoid long-term holds due to erosion from roll-down and leverage decay (see historical performance!).

SVXY – The Carry Trade Proxy

• Ideal for profiting from prolonged calm periods and the contango structure.
• Acts like a carry trade, offering a positive drift—but must be paired with robust stop-loss rules or exit strategy to guard against sharp spikes in volatility.

Switching Strategies

• Tactically rotate in/out of SVXY based on short-term volatility indicators.
• One common signal: VIX9D crossing above or below VIX, i.e. long SVXY if VIX9D crosses under VIX, staying long while VIX9D < VIX, closing long SVXY position when VIX9D crosses over VIX. Some traders also use crossovers with VIX3M or the individual expirations of the VIX futures curve to manage entries.
• Switching between SVXY and VXX based on crossover triggers through the VIX futures curve is often advertised, but very hard to get working in practice due to the importance of timing the VXX entry and exit – signals from the VIX curve may not signal VXX entries and exits timely enough.

Term Structure-Based Combinations

• Combine short VXX with long VXZ (an ETP tracking longer-dated VIX futures, balancing the 4th to 7th VIX contracts to achieve a constant expiration of 60days).
• Weighting is determined by the Implied Volatility Term Structure (IVTS), calculated as VIX / VIX3M. This approach adjusts positions based on the shape of the VIX futures curve, indicated by the IVTS. For instance, when the VIX futures curve shifts from contango (where near-term futures are cheaper than longer-term ones) to backwardation (where near-term futures are more expensive), it involves reducing short positions in VXX and increasing long positions in VXZ.
• This approach mimics the spirit of a calendar spread strategy in VIX futures and reflects the “S&P 500 Dynamic VIX Futures Index”, with weightings backed by research from Donninger (2011) and Sinclair (2013) - see performance chart and weighting-matrix enclosed in the introductory chart).
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VIX Curves as Market Indicators

Beyond trading, VIX instruments and their term structure are widely used as market sentiment gauges. For instance:
Signs of Market Calm:

• VIX9D < VIX
• VIX < VIX3M
• VIX < VX1
• VX1 < VX2

These relationships imply that short-term volatility is lower than longer-term expectations, indicating near-term calmness in markets, occasionally leading to market complacency.
Traders and institutions use these signals to:

• Adjust positioning in broad market indices
• Determine hedging requirements
• Evaluate suitability of selling naked options
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Final Thoughts
VIX ETPs offer a powerful toolkit for traders seeking to profit from or hedge against volatility. But they come with structural decay, leverage dynamics, and curve risk. Timing, strategy, and risk control are key.