UVIX: Leveraged Volatility ETF Has A Specific Function

The 2x Long VIX Futures ETF (BATS:UVIX) tracks twice the performance of a portfolio in long VIX futures. The leveraged strategy based on the VIX Index is essentially a bet on volatility, or more precisely, the expected market volatility through equities in the S&P 500 Index.

In a market sell-off, fear and uncertainty climb, translating to larger price swings and a higher cost of hedging. In this scenario, the fund can climb higher making it useful for tactical trading purposes. UVIX can work within a diversified portfolio ahead of a leg lower in stocks to balance some losses as a short-term hedging instrument. Investors can also use the ETF to speculate on a looming spike in volatility.

What is the UVIX ETF?

The UVIX ETF was launched in March this year meaning that it’s reaching its 6-month anniversary. The timing of the fund’s inception has put the strategy to the test considering the historic volatility in the market this year. The good news is that UVIX has performed as intended thus far with the data showing it consistently delivers around 2x the daily performance of the underlying Long VIX Futures Index and over particular time frames.

In analyzing UVIX we’ll use the iPath S&P 500 VIX Short-Term Futures ETN (VXX) as a VIX benchmark, recognized as one of the largest and most liquid VIX tracking ETFs, but notably un-levered compared to UVIX. In other words, UVIX should outperform VXX by 2x on any given day to the upside or decline by twice as much on a day the VIX pulls back.

For example, this week the Fed hiked rates by 75 basis points at the September FOMC. While the increase was largely expected, the messaging during the press conference by Chairman Jerome Powell was interpreted as particularly hawkish, noting further increases in interest rates could lead to higher unemployment and slowing economic conditions. Naturally, risk aversion took over as the S&P 500 (SPY) sold off by more than 1.5% while the VIX Index climbed from 27.00 to 28.20 on the day, a 4% move higher.

The chart below which highlights how UVIX climbed by 8.9% (closed up by 6%) compared to a 4.0% move in VXX while the SPY ETF was technically down by 2.3% over the full day on September 21st. Note that the percentage changes in the chart below include some illiquid after-hours trading. The point is that taking the performance of UVIX from any other particular day where stocks suffered a deep selloff and the VIX climbed captures a similar dynamic.

On the other hand, it’s important to remember that a decline in volatility is this strategy’s enemy that amplifies losses. Even amid the current market environment, the S&P 500 is trading nearly flat to its level three months ago in June when it reached the year’s low. Here UVIX is down 41% in the period compared to a -23% decline in the unleveraged VXX ETF. The fund also underperforms the alternative ProShares Ultra VIX Short-Term Futures ETF (UVXY) has a similar 1.5x long VIX futures strategy as UVIX. By this measure, UVIX is more aggressive.

This latter chart should serve as a warning against holding UVIX or any other volatility strategy derivative over longer periods. Since the fund inception date in late Q1, UVIX is down 27%, coincidently matching the 1x alternative iPath VXX ETF which declined by 26% over the period. That being said, it’s more notable that the S&P 500 declined by an otherwise historic 18% meaning UVIX and the VIX Index did a poor job as equity hedging instruments over this time frame.

Indeed, the actual VIX Index is higher today than at the end of Q1 meaning the correlation breaks down over time. UVIX as a leveraged fund is dragged lower by the combination of its futures tracking strategy costs, the structure of VIX as a derivative, and the mechanisms required to manage the ETF.

An investor at the end of Q1, convinced that volatility would climb sending stocks sharply lower into near a bear market, would simply have been better off reducing equity exposure or utilizing an inverse vanilla short stock market ETF. For example, the ProShares Short S&P 500 (SH) that tracks -1x the inverse performance of the S&P 500 returned 18% since March while the -2x leveraged ProShares UltraShort S&P 500 (SDS) returned 35%.

What’s Next for UVIX?

The most bullish setup for UVIX would include some scenarios where economic conditions deteriorate materially further and the stock market takes a big leg lower. Doom and gloom scenarios like an escalation of the Russia-Ukraine conflict into Europe or even a high-profile corporate bankruptcy from left field, for example, would likely translate into a surge in the VIX. The trade could also work ahead of an important economic report where the data surprises negatively. On those types of headlines, UVIX could outperform even leveraged short equity ETFs by a significant margin as its main attraction.

The other side is simply that volatility trends lower, possibly driven by better-than-expected macro data, and more positive momentum in risk assets. A scenario where stocks trend lower but the VIX remains relatively stable would also be bearish for volatility. Ultimately, we expect the fund to trend lower in share price over time. The takeaway here is that UVIX is extremely speculative and high-risk, making it not appropriate for most investors. While the fund may appear compelling in the current market environment, investors looking to hedge volatility and stock market losses should look for other risk management alternatives.

The importance of timing volatility and UVIX cannot be understated. The underlying futures strategy of rolling over the expiring front-month contracts makes the fund structurally lose value over time. One suggestion would be to avoid holding UVIX for more than one week. If the trade with UVIX doesn’t work out as expected almost immediately, an exit may be warranted.

Final Thoughts

With UVIX as a newer ETF presenting a limited trading history, we’ll need more time and performance data to completely assess its record against benchmarks. We don’t recommend the fund but recognize that it has its place within some traders’ toolboxes for a specific function being an aggressively bullish outlook for higher volatility. For investors looking for a portfolio hedging instrument, we believe simpler inverse stock market index ETFs may be a better option.