Volatility for Dummies: VXX UVXY VXX and SPY Correlation Explained

by AllDatDalton

The most basic thing to know is that VIX (so VXX and UVXY by extension) is a measurement of market volatility, not SPY performance.  Let’s say you buy a bunch of AAPL options of one month expiry at an implied volatility (IV) of 50 and FB at an IV of 20, but you have them ending up the same percentage higher at the strike price of your one month expiry–let’s say 5% higher.  The logic is that, due to historical and current factors, AAPL is expected to bounce around in much higher and lower swings to reach that 5%–a wilder journey, but the same destination.  The volatility of that journey is what VIX represents, on an extrapolated level, for SPY as a whole.  Think of it like this–VIX is the measurement of IV for the market as a whole, rather than for an individual equity. Because of this…

VIX does not have to always directly inverse SPY, but instead just often does—80% of the time. VIX can rise with SPY–or fall with SPY–it’s just not as common as inversing SPY.  It can also do it’s own thing entirely.  Certain sectors can be performing one way, and SPY another, and these performances factor into the underlying measurements to prevent a break with SPY due to weighting and a shitload of other factors.  SPY can climb rapidly, and volatility can rise with it, because the sharp movement creates just as much variation chaos in the underlyings as a precipitous drop would.

VIX is represented as an annualized standard deviation number within SPY.  If VIX is 25, for example, it is estimating movement of 25% in price action in SPY over the course of the next year.  It was above 50 during the March crash, which, when you think about it in those terms, is nuts.

VIX is a monthly price estimation based on SPY options premiums.  SPY trades on it’s underlyings and is also tradeable in and of itself, whereas VIX is vessel for trading a bundle of spreads, for lack of a better term.  This is a mathematical–even theoretical–estimate on future market movement based on how much premium people are willing to pay for S&P options, or in other words, it is an estimate of market volatility based on how much money people are willing to pay for insurance on their stocks.  Equity prices are ONLY as important here inasmuch as they effect the pricing of the equity options. The more people are willing to pay for options, the higher VIX goes.

VIX is NOT the in-the-moment measurement of the underlying SPY put/call option spread—it is forward looking to the monthy expiration.  In the case of VIX this is a minimum of 23 days and up to 37 days out, with weighting favored toward the one month expiration.  The math is crazy and intricate, on some Rainman shit, but the important thing to know is that VIX isn’t a prisoner of the moment, but instead a look at the coming one month landscape taking in all factors over that course in time.

Real life example: Many people have been expecting VIX to be much higher as we head into an election, but if we think of it in forward-looking, weighted terms, this moment may have passed–at least as far as the election is concerned.  VIX is taking into consideration, at the moment,  the perceived calmer times beginning toward the end of November after the election.  If you go back and look at VIX values about one month prior to the election date, you can see that VIX was at it’s peak on October 5th and 6th, reaching appproximately $30.  This would correlate with the expected movement weighted one month from that day, or in other words, peak fear a day or two after the election.

Volatility is volatile, and therefore not a buy and hold: VIX associates VXX and UVXY are known for making people rich on days like June 11th, or in September, when they suddenly climb 10, 15, 20% in a single day or a two day stretch.  Yes, this a large part of it’s appeal.  But the real reason people get rich is that VIX IV can climb high–fast–because it’s price movements are not considered lasting and great fluctuation becomes priced in.  IV shoots up on these things like crazy, which means that the value of your VIX options shoots up like crazy.  BUT, value also falls like crazy too, and it has intense theta burn (cost appreciation of the asset over time). So, while you are sitting around waiting to make your million dollar play with a VXX monthly you are losing a lot of money in the process.  The VIX knows this, and it smells your weakness, and the day after you’ve dumped it because you’ve bled 50% it will rocket to new heights.  Because of this…

VIX, VXX, and UVXY are meant as loss strategies and hedges, but not as outright plays.  Unless you are some Burry level TA specialist, or maybe my guy /u/winnning007, and you can pinpoint when certain events are going to happen or the market response within a day or two, you’re best to keep a smaller amount as a hedge rather than go all in.  The road to bagholding is short and full of terrors with volatility plays. BUY SPY PUTS INSTEAD IF YOU ARE BEARISH

VIX VXX and UVXY——————-

So all that is cool, but VIX is a futures instrument and not a daily tradeable ETF/ETN; enter VXX and UVXY.  To keep it simple, I’m going to lump the two together and just say that UVXY is a more levered version of VXX.  So UVXY can climb higher than VXX when it rises, and fall lower than VXX when it falls.  For the purposes of this explanation, I’m going to focus on VXX, but bottom line–if you don’t really know what you’re doing/aren’t confident in your volatility move, stick with VXX rather than UVXY.  The money is still good, don’t be a hero.

VXX tracks the performance of VIX, but offers different expirations (weekly ETF settlement dates like Friday/Saturday rather than the Wednesday of monthly futures), and tracks it at about a 50% level.  In other words, if the VIX monthly futures have an 8% jump, expect about 4% for VXX monthlies.  VXX is also an ETN, not an ETF–this is important because it means that it must have a direct tracking of the VIX unlike a fund which isn’t beholden to a certain rate of correlation.  In other words, VXX MUST track that ~50% of the VIX for efficacy.

What’s important here: VIX is the futures estimate bundle, and VXX is not VIX, but it is a very reliable tracker of VIX price movements with few notable exceptions.  UVXY is kind of like a levered version of VXX, meant to track with higher returns. These two can and do at times move out of sync with VIX due to something called contango.

If you want to go in depth on the intricacies of their relationship and contango and shit, I won’t do that here, but this is a good resource: www.schaeffersresearch.com/content/news/2015/02/04/the-messy-relationship-between-vix-and-vxx


Whenever VXX doesn’t move with SPY, I bitterly joke that it’s illegal and manipulated.  This wayward movement is actually more due to the natural variance I pointed out earlier, but there is some truth to it.  CBOE–the VIX providers–have been sued a few times over the past few years due to alleged manipulation of VIX.  Of note, the “Father of VIX” as one article called it’s creator, was one of the whistleblowers alleging fraud.  The case was recently thrown out again, but the accusations speak for themselves.

The plaintiffs, traders in VIX-based products, filed a lawsuit alleging that certain features of the settlement process made it especially susceptible to manipulation but that Cboe chose not to enforce its rules against manipulation so it could continue to profit from the VIX products. Specifically, the complaint alleged violations of the Exchange Act antifraud provisions and the CEA and brought claims against both Cboe and anonymous “Doe” defendants that allegedly manipulated the settlement values for VIX options and futures by manipulating the two-zero-bid rule and employing a process analogous to “banging the close.”

So, ya know, innocent until proven guilty, but there is a lot of info out there to suggest that a lot of people invested in–and involved in the creation of–VIX through CBOE think it’s manipulated.  That can’t be ignored.

Other tidbits to note: A lot of little things matter with VIX; Quad witching dates, portfolio rebalancing dates, Congressional hearings with the FED, release of beige books, stress tests, and FOMC are all catalysts for VXX/UVXY activity if you’re searching for short dated FD plays.  Just look at the financial calendar on the FED website or Marketwatch, etc., before you make any moves against volatility. You’re one JPOW speech to congress away from the big GUH.

Positions: This was meant to be informative more than predictive.

That said, I don’t have a phenomenal read on this market–I’m not a TA guy generally, and a lot of the fundamentals are out the window as we approach the election.  BUT, I expect anticipation of lame-duck political activity should there be a Blue Wave, PLUS uncertainty around COVID second wave restriction regression, PLUS the unveiling of a variety of coming tax changes in a Biden win, will likely bring higher pricing in option premiums and thus higher VIX.



Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.