Key Takeaways
- Downgrade to ‘Sell’: The iPath S&P 500 VIX Short-Term Futures ETN (VXX) has been downgraded to a “Sell” rating amid signs that market volatility is overpriced.
- Elevated VIX: The Cboe Volatility Index (VIX), often called the market’s “fear gauge,” is currently at a high level, which historically precedes a decline.
- Year-End Trends: Analysts anticipate a seasonal decrease in market volatility as the year concludes, putting downward pressure on VXX’s price.
- Inherent Decay: VXX is susceptible to “volatility decay,” a structural issue that often causes its value to decrease over time, making it unsuitable for long-term holding.
As the year draws to a close, investors betting on market turbulence are being cautioned. The iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX), a popular tool for trading short-term volatility, has been downgraded to a “Sell,” signaling that the current high level of market fear may be about to subside.
This downgrade is rooted in the elevated pricing of the Cboe Volatility Index (VIX), which the VXX aims to track through futures contracts. With the VIX hovering in what analysts call a “rich” zone, historical data suggests that a period of lower volatility is likely on the horizon.
The Case Against VXX
Why Volatility is Expected to Decline
The primary driver behind the bearish outlook for VXX is the expectation of a “volatility drain” into the end of the year. This seasonal trend, combined with a generally bullish outlook for equities, often leads to calmer markets. When stock markets perform well, the demand for protection against downturns—which is what the VIX measures—typically falls, pushing its value down.
For VXX, this is a significant headwind. Since it tracks VIX futures, a falling VIX directly translates into losses for the ETN.
Understanding Structural Decay
Beyond market trends, VXX has a built-in challenge known as price decay. This occurs because the ETN must constantly roll its portfolio of VIX futures contracts. Often, futures contracts with later expiration dates are more expensive than those expiring sooner. This market structure, known as contango, forces VXX to sell low and buy high, creating a steady drag on its price over time.
This inherent decay makes VXX a tool best suited for very short-term, tactical trades rather than a long-term investment.
Technicals and Investor Outlook
Technical indicators for VXX are also flashing warning signs. The ETN is showing bearish momentum, with its price trading below key long-term averages. Analysts note that even with recent increases in trading volume, the instrument faces significant resistance at higher price levels.
For investors, the message is clear: the current environment is unfavorable for holding VXX. The combination of an overpriced VIX, seasonal trends, and the ETN’s structural flaws suggests further downside is likely. As the market heads into the holiday season, selling volatility appears to be the recommended strategy.
Image Referance: https://seekingalpha.com/article/4845790-vxx-the-vix-is-rich-sell-volatility-into-year-end-downgrade