The VIX futures (quotes) term structure is upward sloping, or in contango, the majority of the time and only enters backwardation during VIX spikes. Someone used to a 1-2% front month negative roll yield in the oil futures may be shocked by the 10-20% front month negative roll yield that can exist in the VIX futures market.
To summarize from the VXX prospectus, the VXX rolls its VIX futures holdings daily to maintain holdings with a weighted average of 30 days until expiration. Someone with an infinite time horizon who never suffers a margin call from a VXX short is almost guaranteed to make a large return. Unfortunately, no investor has infinite margin along with an infinite time horizon. The fact that VXX could easily double in the course of a week makes people afraid to short VXX, as it's still easy to borrow.
The key to shorting VXX is to make it a pure mathematical trade and give up trying to time an entry point. One such strategy is to dollar cost average 10% of your portfolio into a short VXX position over the course of a year. Then add to the position to maintain the short as 10% of your portfolio. I have begun doing this by selling out of the money Jan '12 LEAPS, and using the delta of my positions as a measure of my short exposure.
Although 2008 changed everything, a look at historical VIX futures prices (available since the contract began trading in 2004) makes it clear the steep term structure that exists today was not around during the "old normal." After the trauma inflicted upon money managers in 2008 they are willing to pay a hefty price for VIX futures as portfolio insurance. It has become popular to be prepared for the next black swan by holding VIX futures or calls, and the expected lose in these positions is considered a new cost of doing business.
Until the VIX futures term structure flattens when the cash VIX is under 20, I will remain short VXX. I think the steep term structure is here to stay though. Otherwise, the insurance would be too cheap. The possibility that something "Too Big to Bail" is only a few months away is too great.
To summarize from the VXX prospectus, the VXX rolls its VIX futures holdings daily to maintain holdings with a weighted average of 30 days until expiration. Someone with an infinite time horizon who never suffers a margin call from a VXX short is almost guaranteed to make a large return. Unfortunately, no investor has infinite margin along with an infinite time horizon. The fact that VXX could easily double in the course of a week makes people afraid to short VXX, as it's still easy to borrow.
The key to shorting VXX is to make it a pure mathematical trade and give up trying to time an entry point. One such strategy is to dollar cost average 10% of your portfolio into a short VXX position over the course of a year. Then add to the position to maintain the short as 10% of your portfolio. I have begun doing this by selling out of the money Jan '12 LEAPS, and using the delta of my positions as a measure of my short exposure.
Although 2008 changed everything, a look at historical VIX futures prices (available since the contract began trading in 2004) makes it clear the steep term structure that exists today was not around during the "old normal." After the trauma inflicted upon money managers in 2008 they are willing to pay a hefty price for VIX futures as portfolio insurance. It has become popular to be prepared for the next black swan by holding VIX futures or calls, and the expected lose in these positions is considered a new cost of doing business.
Until the VIX futures term structure flattens when the cash VIX is under 20, I will remain short VXX. I think the steep term structure is here to stay though. Otherwise, the insurance would be too cheap. The possibility that something "Too Big to Bail" is only a few months away is too great.
Disclosure(s): short VXX at time of writing
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