VXX Expensive Again

Looking at the SPX index, actual annualized volatility has been below 10 for the past couple months, which is very low historically. Funny you don’t hear about Taleb or Spitznagel when vol crashes, only when it spikes (talk about a convex payoff!). See below for a chart.

The VIX futures, which are closely related, show that not only is the VIX spot relatively high, but the future volatilities are even higher. The slope of the futures curve is very high. As the VXX and TVIX are hedged via riding down the futures curve, this suggests above-average costs of using the VXX to hedge one’s equity exposures.

Now, the betas formed by regressing against the SPX vs those formed against the VXX form an almost perfect linear relationship (this was done using 5-minute returns for 800 non-ETF stocks). Note the higher the SPX (aka regular) beta, the more negative the VXX beta, so one can translate a position into VXX pretty easily, and by going long (plus, you can use the TVIX, which gives twice the exposure per dollar).

Many people hedge equity positions by going long volatility, and this does make sense because the VXX beta is around 2.3, so you seem to get a lot of bang for your buck. But the current contango suggests you are going to lose way more than 10% more than the VIX over the next year, so, that’s a tax worth rethinking. Last year, this trade wasn’t so expensive, as the futures curve had about one fifth the slope, but this year’s slope is ridiculously steep.

If you want less equity exposure you should lower your beta or volatility by adopting a low volatility tilt. Alternatively, allocate less money to equities. It doesn’t make sense to pay insurance that costs more than anyone’s equity return premium.

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