I want to introduce you this week to two exchange-traded funds (ETFs), launched by ProShares on Jan. 4, that allow you to hedge against the kinds of big market swings that occurred last year.

The first fund is the ProShares VIX Short-Term Futures ETF (VIXY), which seeks to provide investment results, before fees and expenses, that match the performance of the S&P 500 VIX Short-Term Futures Index. The second one, the ProShares VIX Mid-Term Futures ETF (VIXM), is similar but its futures are for longer periods of time, since it seeks to provide investment results, before fees and expenses, that match the performance of the S&P 500 VIX Mid-Term Futures Index.

Here is how these ETFs work. The S&P 500 VIX Short-Term Futures Index measures the movements of a combination of VIX futures and is designed to track changes in the expectation for one month in the future. The Index maintains an 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 on a daily basis.

In contrast, the S&P 500 VIX Mid-Term Futures Index measures the movements of a combination of VIX futures. The latter fund is designed to track changes in the expectation for VIX five months in the future. That Index maintains an average weighted settlement date of five months in the future by rolling a portion of the position in the fourth month VIX futures contract into the seventh month VIX futures contract on a daily basis.

If all of that sounds a little complicated, the following background information might help. The CBOE Volatility Index (VIX) is a commonly followed measure of the expected volatility of the S&P 500 for the next 30 days. However, since you cannot invest directly in the VIX index, exposure to equity volatility often is obtained though VIX futures. Also keep in mind that the price of a VIX futures contract reflects the market expectation for the level of VIX on the settlement date of the contract.

Basically, VIX measures how volatile investors expect the market will be in the coming month. In the past, investors have had access to funds tied to the Volatility Index, but they were limited to exchange-traded notes (ETNs) rather than ETFs. These new funds don’t have nearly the same credit risk as ETNs, which are unsecured debt securities that depend on a single company’s ability to pay.

If we see the same kind of volatility this year that we observed in 2010, these funds could do quite well. The chart below shows the extreme peaks and valleys we experienced during 2010 and the beginning of this year.

We started off 2010 on the back of a very nice surge in December 2009. Then, midway through January, we witnessed a sharp pullback of 7.2% that lasted until early February. Buyers stepped in forcefully after that initial sell-off, and by late April, the broad measure of the domestic equity market had surged some 13.8% off of its February low.

Of course, volatility in 2010 continued throughout the year. May ushered in a huge sell-off that was precipitated by the “Flash Crash” on May 6, when the Dow incurred its largest intraday decline in history. The shock was temporary and the market recovered much of those losses within minutes. However, the selling tone definitely had been set. Except for a bit of buying in early June, stocks basically continued falling until they slid to their 2010 low in early July.

Once SPX dipped into the range of 1,020, investors began buying again and that triggered a surge in equities. From early July until early August, we saw a 9.8% spike in the index. But once again, sellers stepped in, lopping off 6.1% of the S&P’s value by the end of August. After that, the real volatility began!

Stocks began a seriously bullish run in September that took SPX up 6.8% in just over three months. Stocks reached their peak in early November, just after the midterm Congressional election and right after the Federal Reserve’s announcement of quantitative easing part II, or QE2. After stocks hit their November peak, we absorbed a pullback of 3.6% that lasted right until the beginning of December.

Stocks again have fought their way back. In fact, we ended 2010 at new 52-week highs, a feat I don’t think most market pundits really believed would happen. And that nice run higher has continued through the end of January, rising 10.08% through Jan. 27.

My analysis is that the coming year could bring about the same, if not more, volatility. So, VIXY and VIXM may be wise additions to your portfolio. Since the funds are new and have not achieved the minimum 100,000 average daily trading volume that I like to see before recommendation, I am not ready to advise you to buy yet, but they certainly are worth watching.

For advice about which ETFs to buy and to sell, I urge you to sign up for my ETF Trader service. As always, I am pleased to answer any of your questions about ETFs, so don’t hesitate to contact me if you have one. To send a question to me, simply click here. You may just see your question answered in a future ETF Talk.