VXX: What is it and How Does it Work?

If you’re a trader who wants to take advantage of different types of assets, you may want to add this ETN to your arsenal. 

Created in 2009, its main function is to track movements in the S&P 500’s implied volatility. This is measured by using the VIX index. Since its inception, it has become a successful way to provide exposure to changes in the VIX index.

What Is VXX?

Changes in the volatility of the stock market can occur when there is disruptive news or significant announcements. Traders will rush to take new positions, adding to the volatility. The VXX was created by Barclays to help traders take advantage of this volatility in their portfolios. It offers exposure to changes in the VIX index via VIX futures contracts. 

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If you believe there will be an increase in volatility due to news that may be coming, you may want to go long this ETN. In contrast, you can also short this ETN if you believe there’ll only be little to no volatility in the short-term future.

Understanding the Role of the VIX Index

To better understand how this ETN works, it’s best to define the S&P 500 VIX Short-Term Futures Index function. The VIX Index is designed to offer traders access to market volatility. 

During periods when volatility is increased, the VIX Index will rise in value. However, due to it not being an asset, traders are unable to buy or short it. Offering an ETN that tracks the VIX solves this challenge. 

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It was designed to allow traders to take advantage of short-term market volatility by following the movements of the VIX Index. It offers exposure to the VIX futures contract using a position in the first and second-month futures contracts.

Tracking the First and Second Month Futures Contracts

The VIX Index uses multiple SPX options expiration cycles to measure a 30-day constant weighting. According to tastytrade, the ETN “is a portfolio composed of the front two months /VX futures that bear continuously changing weights.” 

This calculation is completed since there aren’t 30 days to a settlement with a VIX futures contract. The formula uses a 50 percent weighting of each month’s days to settlement and combines them to derive the weighted 30 days to settlement figure. 

It then calculates the price by combining a 50 percent weighting of each month’s price. If these figures go up or down, it’s reflected in the value of the ETN, which can be traded.

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Daily Movement Examples

Daily movements for the ETN are based on the closing price of the previous day. For example, if the ETN was $30 and there is a 10 percent increase in the 30-day VIX futures, the ETN’s price would increase to $33. If the next trading day recognized another 10 percent increase in the 30-day VIX futures, the cost of the ETN would rise to $36.30. 

This type of movement can increase exponentially if there is a consecutive streak of increased values for the VIX.

Having the ability to leverage the value of the VIX can be an excellent way to take advantage of short-term volatility. Using the ETN wisely can help add even more money to your bottom line.

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