Sophisticated investors with a long-term view could use IPath S&P 500 Short-Term Futures ETN VXX to partially guard their portfolios against future downturns....
VXX is peddled as portfolio insurance to sophisticated investors with a long term view. Well, that rules me out. Your choice, do you put 1%, 5% or 10% of your portfolio in such an instrument ?
Up 30% in May... not bad ! Those with an insurance policy are glad.
Now let's look at the "book value" of VXX. Are we buying anything cheap and/or is there a chance the value will grow over time. Is there a margin of safety ?
It's clear from the desicription.... the underlying assets of VXX are VIX futures. The "company" called VXX sells this weeks volatility "insurance" contracts and uses the money to buy contracts for next month; they keep rolling the contracts over. If poeple are more worried about this week than they are about next month, this is a highly profitable business. We saw that happen in May.
The problem with this business model is that this weeks contracts are almost always cheaper. Not because poeple generally expect next month to be more volatile than this week, but simply because there is less demand for insurance against this weeks events. The market assumes this weeks risk is already in the prices.
In short, the underlying contracts become worth less at a rate of about 5% A MONTH for fundamental reasons. Don't take my word for it; look at the data: http://cfe.cboe.com/Products/historicalVIX.aspx and I'm not even counting trading costs.
I ask again, do you wan't 1%, 5% or 10% of your portfolio in an asset that is certain to be worth 50% less in a year. Just look at the value of VXX in June last year. Keep in mind that we recently had a spike in volatility so this is about as good as it gets for the business called VXX.
VXX was is not designed to track VIX; it is DESIGNED TO GO TO ZERO.... and the SEC is going after Goldman.
IMO VXX is an excellent short.