Volatility ETFs provide a way for investors to profit from uncertainty and hedge against market downturns. Here we’ll look at the 3 best volatility ETFs to capitalize on market swings.
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Introduction – What Is Volatility?
Volatility refers to the measure of dispersion – or variability – of returns of a security of index. Picture a graph that resembles a roller coaster with peaks and valleys of the movement of a stock or stock index.
Generally, higher volatility indicates greater investor uncertainty. Market crashes are generally instances of the highest market volatility. Conversely, periods of low volatility are correlated with upward market movement. As such, volatility ETFs are an excellent way to hedge against periods of market turmoil, providing a strong negative correlation to stocks. They also allow speculative traders to profit from market downturns.
These ETFs typically track a volatility index, usually the Chicago Board Options Exchange Market Volatility Index (VIX), an index representing a 30-day forward-looking expectation of market volatility. It is known colloquially as the “fear index,” as volatility is synonymous with risk. Essentially, this index spikes in tandem with investor anxiety.
Note that these products are best used over short time periods and are likely unsuitable for holding long-term. Also note that all exchange-traded products based on the VIX are using an index comprised of futures contracts and are not a direct investment in the index itself.
Let’s explore the best volatility ETFs.
The 3 Best Volatility ETFs
Below are the 3 best volatility ETFs that trade in the U.S. All 3 are based on the same aforementioned index (VIX) but have slightly different structures, average maturities, and fees.
VXX – iPath Series B S&P 500 VIX Short Term Futures ETN
VXX is the most popular volatility ETF, with over $1.1 billion in assets. It seeks to track the S&P 500 VIX Short-Term Futures Index. This ETN has an average 1 month maturity of its futures contracts exposure and its exposure resets daily. VXX has an expense ratio of 0.89%.
VIXY – ProShares VIX Short-Term Futures ETF
VIXY is a comparable product to VXX in providing exposure to short term VIX futures with a 1 month average maturity, but VIXY is instead structured as a commodity pool. The upside of that fact is that VIXY avoids the counterparty risk and lack of tangible assets inherent with ETNs, but also generates the more annoying K-1 form at tax time. This ETF has an expense ratio of 0.87%.
VIXM – ProShares VIX Mid-Term Futures ETF
The previous two volatility ETFs have an average maturity of 1 month. VIXM provides exposure to medium-term VIX futures with an average maturity of 5 months, making it better for holding longer. This means VIXM doesn’t suffer as much from contango as its short-term counterparts, but it also means its movement will not as closely match that of the VIX. Like VIXY, this ETF is also structured as a K-1-generating commodity pool and has an expense ratio of 0.87%.
Where To Buy These Volatility ETFs
All the above low volatility ETFs should be available at any major broker. My choice is M1 Finance. The broker has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, intuitive pie visualization, and a sleek, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.