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Volatility ETFs Crash as Market Fears Drop

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The U.S. stock market saw a soft start to the year on rising fears of a faster QE taper, the subsequent withdrawal of cheap dollars, as well as the emerging market lull. But the scenario took a sharp turn with downbeat job, retail and manufacturing data, which sent markets tumbling (read: 3 Low Risk ETFs for a Stormy Market).

The data once again spurred the possibilities of a slower QE wrap-up and the market once again turned its attention toward the safer assets. As a result, the volatility index (the VIX) – often regarded as a fear gauge level, which touched a 13-month high of 21.4 earlier this month thanks to the stock slump – has been bleeding heavily while the S&P index gained modestly during the same time frame.

Volatility products tend to outperform when markets are falling or fear levels over the future are high. As neither of these events came to pass thanks to the muted economic indicators in the U.S., we saw a sharp downturn in volatility-backed products.

Downturn in Volatility Products

This year, the Fed lowered its purchase of mortgage-backed securities to $30 billion a month and of Treasury securities to $35 billion per month. However, the Fed’s new Chairperson, Janet Yellen, recently commented that the future course of the Fed Taper will depend on the pace of the economic recovery and the bond-buying program’s pace is not pre-determined (read: 3 ETFs Surging on Weak Jobs Data).
Amid such a scenario, soft retail numbers for consecutive two months and a weak labor market along with the weak ISM survey and soft durable goods and factory order readings stirred doubts over true economic recovery in investors’ minds, thereby lessening the fears of a faster taper. Since $65 billion per month is still a massive amount regardless, volatility products saw dire trading in the last couple of days.

The fear-gauge CBOE Volatility Index (VIX) plunged about 29% to settle at $13.57 in just over the last 10 days. The index is constructed using implied volatilities of the S&P 500 index options, taking both calls and puts into account (read: Volatility ETFs Skyrocket on Broad Market Weakness).
A popular ETN option providing exposure to volatility, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) shed 15.26% in the last 10 trading sessions. The trading volumes were also below the average level. The losses were massive in two leveraged products – VelocityShares Daily 2x VIX Short Term ETN (TVIX) and ProShares Ultra VIX Short-Term Futures ETF (UVXY) that shed about 30% in the said time frame.
The investors’ mindset seems bolder for the short-term period rather than the mid term as a decline in the medium term volatility productiPath S&P 500 VIX Mid-Term Futures ETN (VXZ) – was relatively lower than the shorter ones. While all the short-term products were down in the range of 15%, the mid-term ETN – VXZ – tumbled 7.0%.
Bottom Line

In our opinion, doors will not open up for the volatility products in the coming days, especially until any high-flying macroeconomic data come out and stir up speculation on a further escalation in the taper (read: Hedge Your Portfolio with Low Volatility ETFs).

To add to this, the Obama government has successfully raised the debt-limit to March 2015 putting an end to the five-month long debt-ceiling talks. Thus, investors can easily forget volatility as of now, and might try out investing in other assets for the time being.

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