Making Money Alert
ETF Talk: Predicting the Future Profitability
08/31/2011
When the markets are in turmoil, we know that volatility increases. Professional investors will look at the VIX or the Chicago Board Options Exchange’s volatility index, also known as the “Fear Gauge,” to get a closer idea of how much the market will move in the coming months. You can’t buy or sell the VIX as an investment play, but you can purchase VIX futures or, more simply, shares in the ProShares VIX Short Term Futures (VIXY).
VIXY is an exchange-traded fund (ETF) that seeks to provide investment results (before fees and expenses) that match the performance of the S&P 500 VIX Short-Term Futures Index. The index, the benchmark for VIXY, measures the movements of a combination of VIX futures and is designed to track expected changes one month in the future. The index uses a constant average weighted settlement date of one month by rolling a portion of the position in the first month VIX futures contract into the second month VIX futures contract each day. This ETF, as of August 30, 2011, was holding 471 September VIX futures and 336 October VIX futures, with a market value of $25.5 million.
The intent is to let you earn a profit in the ETF by benefiting from the market’s volatility. Indeed, the larger the VIX number, the higher percentage changes up and down you can expect to see in the equity indexes. Generally, the more bad news and uncertainty in the market, the higher the VIX number goes and the larger your profits.
An investment aimed at profiting from volatility generally would be a short-term trade. You ideally would want to buy when volatility is low and you start to detect ominous signs that the market is due for at least a near-term setback. If you buy VIXY at the right time, it can be a fast-moving ETF to the upside when things are going wild in the markets. But a few slow days can send the VIXY downward.
Here’s a final word of advice about VIXY. Since it is structured as an ETF, it is treated differently for tax purposes than certain other volatility-related investment products, such as the exchange-traded notes iPath S&P 500 VIX Short-Term Futures (VXX) or VelocityShares VIX Short-Term ETN (VIIX). So, I encourage you to talk to your tax adviser about how the differences between ETFs and ETNs may affect you.
As always, if you want my advice about buying and selling specific ETFs, including appropriate stop losses, please consider subscribing to my ETF Trader service. I am happy to answer your questions, so do not hesitate to email me by clicking here. You may see your question answered in a future ETF Talk.