Chart VXX At Your Own Risk

• Posted by Adam Warner
• on July 15th, 2010

So I went over to RM yesterday to see if Cramer’s Pretend Wednesday Expiration Look had returned. It hadn’t. But did catch this in Columnist Conversation from Not Cramer.

Traders are buing some volatility seemingly on release of the FOMC minutes. But, Elliott Wave analysis allowed us to talk about this buying opportunity yesterday morning’s Columnist Conversation: “…we should watch for VIX to bottom and move higher, sending the stock market indices lower. The iPath S&P VIX (VXX), the ETF that benefits from rising VIX, could be interesting for those who want to bet on volatility itself. If you do so, allow the $21 level as room on any initial long entry, which is the gap from early May. While it’s not likely to get that low, we cannot rule it out. Perhaps a small long entry on a VXX break above $25, with a secondary entry around $21 might work. The next move above $30 should be wave iii higher, with targets currently near 45+ on VXX. That level is resistance or some Elliott and Fibo measurements and would imply VIX itself near the May highs, and pushing standard deviation extremes”. Intra-day stochastics are crossing up across the board; getting overbought in the very short term. An Elliott Wave impulse is visible on the 30 minute chart, allowing for a retest of 24.85-25.25 if needed. We’re looking for higher volatility in the coming days/weeks.

It all sounds quite erudite. Just saying the word “erudite” sounds erudite. In fact throw Elliiot Wave terms around and you always sound great. And his general opinion on the VIX makes sense. But I could save all that work by just pointing out all VIX futures tell us all there are expectations for a higher VIX. So I suspect something along these general lines will play out, and he can credit his wave impulses.

But here’s my strong advice to you the reader. DON’T CHART VXX. Or at least don’t read much into it.

It’s a trading product only. It’s a derivative that tracks a derivative of a statistic. Perfomance over time in VXX is entirely VIX path dependent. You can’t say “VXX will be at X when VIX gets back up to Y”. If VIX gets back to Y tomorrow, VXX will likely disappoint as futures track less and less of a push higher, especially when they are already at large premiums as they are now. If VIX goes back to Y 6 month’s from now, VXX will also disappoint, but in a very different trajectory  as the drag of the constant contango, as well as gradual futures premium erosiion, causes underperformance.

When VIX hit “the May highs”, VXX got as high as 36. Again, no way to know the future path, but if VIX does actually get back to it’s own May highs, VXX will likely be somewhere in the low 30′s, nowhere near 45.

If you think VIX is going up tomorrow, or for the next few days, VXX is a fine way to play it. If you think VIX is trending higher over time, find some other way to play it (maybe SPY puts…..heaven forbid).

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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