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What Is VXX and How Does It Work?

mindmingles by mindmingles
January 26, 2022
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VXX, a leveraged exchange-traded note (ETN) issued by Barclays Bank PLC. It is designed to track the performance of the VIX, a popular measure of market volatility. It is also known as the VIX short-term futures ETN. It does this by using futures contracts on the S&P 500 Index and rolling them over every month. The fund is structured as an ETN rather than an ETF because it doesn’t hold any assets in custody. 

According to tastytrade, “The VXX is an Exchange Traded Note (ETN) that tracks the VIX short-term futures. To be more specific, the VXX is a portfolio composed of the front two-month/VX futures that bear continuously changing weights. VXX is just one of the available volatility products, and it is important to note that it does not always perform like the other products may (such as the VIX).”

The leveraged ETN was launched in 2009 after the financial crisis when investors began to demand more ways to trade on volatility. The VIX is calculated from S&P 500 options and tends to rise when investors are worried about downside risk in stocks. In general, a higher reading for the VIX suggests that investors are more fearful and would use options to hedge their portfolios or take short positions in stocks.

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The goal of volatility trading is that there will be times when the VIX rises sharply, but stocks remain flat. If you buy a futures contract on the VIX, you are essentially paying for insurance against a sudden fall in stocks. If stocks don’t fall, you can sell the futures contract at a profit.

Many traders use the VIX to hedge their portfolios or trade on volatility directly. They might buy or sell futures contracts on the VIX when they think that it will go up or down.

The problem with buying and selling futures contracts is that you need to put up a margin equal to about 15% of the value of the position. Since future contracts have a daily settlement, you have to do this every day and pay interest on your margin balance. The VIX short-term futures ETN ETN removes these transaction costs because it rolls over its future contracts once per month. Also, it doesn’t have any margin requirements.

How Does It Work?

The leveraged ETN is designed to track the performance of a hypothetical index composed of the first two months of the future contracts on the VIX. The more that investors are worried about volatility, the higher the price of the leveraged ETN will be. A weighted average of its components determines the price:

= [(X1)(X1 Price) + (X2)(X2 Price)]/

Where X1 and X2 are weights given to each month’s future contract.

These weights are determined by how many days are left until the expiration of each contract. The weight for each contract will change every day as expiration draws closer.

When you buy or sell one unit of VXX, you’re purchasing or selling two units of the first month’s futures contract and one unit of the second month’s futures contract. The latter is because there are always two months left until expiration for these contracts, so they weigh 0.5.

The leveraged ETN is structured as a senior unsecured note issued by Barclays Bank PLC. Usually, it is backed by the collateral held in a segregated account at the firm.

The instrument has an annual management fee of 0.75% and a market-to-market daily settlement fee of 0.05%. It was created in 2009 to track the CBOE’s VIX Futures Index, which tracks the price of VIX futures contracts with two months remaining until expiration.

The first-month contract expires monthly, while the second one expires quarterly. There are always two months left until expiration for these contracts.

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