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Volatility ETFs Surge as Market Fear Returns

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Market volatility roared back in recent weeks as soaring yields took a toll on everything from stocks, real estate to the bond market. Notably, the 10-year Treasury yield scaled to 4.84%, the highest level since August 2007 while 30-year yields touched 5% for the first time since 2007.

Yields have risen as the Fed is expected to keep interest rates elevated for a longer-than-expected period. In its latest meeting, the central kept interest rates steady at a 22-year high, in the range of 5.25% to 5.5%, but signaled one more hike this year. Though inflation is easing, it remains elevated and above the Fed’s 2% target. The expectation of higher rates is attracting more investments into the United States as investors seek higher rates than they can get in Europe and Asia, leading to the appreciation of the U.S. dollar (read: Shutdown Fears Bolster Dollar's Safe Status: ETFs to Bet).

Surging oil prices lately have also added to the volatility. Oil has climbed to new highs in 2023 mainly on the back of extended output cuts by Saudi Arabia and Russia, as well as other members of the OPEC+ alliance of oil producers.

Meanwhile, China's economy, the engine of global growth, is in doldrums, on falling consumer prices, a deepening real estate crisis, slumping exports and a record-high youth unemployment rate.

The combination of these factors has raised volatility. The volatility level represented by the CBOE Volatility Index, also known as fear gauge, has risen 41.5% over the past month and 11.8% over the past week. This suggests that market worries have started to set in. This fear gauge tends to outperform when markets are declining, or fear levels about the future are high.

Investors could benefit from this trend. While they can’t directly buy this index, there are several ETF/ETN options available in the market that can provide some exposure to volatility. These products have proven to be short-time winners in turbulent times. Below we have highlighted short-term volatility products that will steadily move higher as long as market turmoil lingers.

iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX - Free Report)

iPath Series B S&P 500 VIX Short-Term Futures ETN focuses on the S&P 500 VIX Short-Term Futures Index, which reflects implied volatility in the S&P 500 Index at various points along the volatility forward curve. The note gives investors exposure to a daily rolling long position in the first and second months of VIX futures contracts. iPath Series B S&P 500 VIX Short-Term Futures ETN is popular and liquid with AUM of $414.1 million and an average daily volume of 11.3 million shares. It charges 89 bps in annual fees (read: Can S&P 500 ETFs Maintain Its 5-Year Best Momentum?).

ProShares VIX Short-Term Futures ETF (VIXY - Free Report)

ProShares VIX Short-Term Futures ETF provides long exposure to the S&P 500 VIX Short-Term Futures Index, which measures the returns of a portfolio of monthly VIX futures contracts with a weighted average of one month to expiration. ProShares VIX Short-Term Futures ETF has amassed $236.6 million in AUM and charges 85 bps in fees per year. It trades in a volume of 5 million shares per day on average.

ProShares Ultra VIX Short-Term Futures ETF (UVXY - Free Report)

Investors seeking huge gains in a very short time frame could consider this leveraged volatility ETF. ProShares Ultra VIX Short-Term Futures ETF offers exposure to one and one-half times (1.5X) the daily performance of the S&P 500 VIX Short-Term Futures Index. It has accumulated $328.9 million and charges 95 bps in annual fees. It trades in a volume of 19 million shares per day on average.

2x Long VIX Futures ETF (UVIX - Free Report)

2x Long VIX Futures ETF seeks twice the performance of the Long VIX Futures Index, charging investors 1.77% in annual fees. It has amassed $79.1 million in its asset base and trades in average daily volume of 14.6 million shares (read: Best Inverse/Leveraged ETFs of Last Week).

Bottom Line

Investors should note that these products are suitable only for short-term traders. This is because most of the time, the VIX futures market trades in a condition known as contango, a situation wherein the near-term futures are cheaper than the long-term futures contracts. As volatility ETFs and ETNs like VXX must roll from month to month in order to avoid delivery, the situation of contango can eat away returns over long periods (see: all the Volatility ETFs here).

However, this seems a good time to add these products to your portfolio as rising yields will threaten the stock market at least in the near term.

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