2x Long VIX Futures ETF: The Compelling Reasons For The VIX (BATS:UVIX)

Volatility is a nightmare for passive investors, but it creates a paradise of opportunity for nimble traders with their fingers on the pulse of markets.

Price variance in markets causes many hearts to skip a beat as portfolio results often encourage or discourage spending. Moreover, market participants saving for retirement, education, or other significant expenses begin to worry during substantial market corrections. Concerns often lead to liquidations or hedging that can exacerbate the impact of market declines.

While traders embrace price variance, investors with significant events on the horizon deplore volatility. The S&P VIX Index (VIX) is a barometer of market fear, as it tends to spike higher when stocks in the S&P 500 Index (SP500) fall and decline during bullish trends. The VIX was trading at the 17 level on May 16, near the bottom of its 2023 trading range of 15.53 to 30.81.

The 2x Long VIX Futures ETF (BATS:UVIX) product follows the VIX higher and lower and leverages its performance on a short-term basis.

The VIX is all about implied volatility

Historical volatility is the price variance measure over history, an objective measure of price ranges and market action. Meanwhile, implied volatility is subjective, based on the market’s overall sentiment of the future price variance.

Implied volatility is the primary input in put and call options pricing. The higher the implied volatility level, the higher option premiums, and vice versa. The VIX index measures the implied volatility of stocks in the S&P 500 index, the most diversified U.S. stock market benchmark index.

Bear markets are bullish for the VIX

Put and call options are price insurance, and market participants tend to buy price insurance during tumultuous periods. Insurance costs tend to increase during and immediately after disasters, and flood and other homeowner insurance premiums increase after a natural disaster. In the stock market, there are two reasons why options premiums and implied volatility rise during selloffs and fall during bullish or stable trends:

• Sudden selloffs or overwhelming bearish sentiment in the U.S. stock market causes market participants to purchase put options to protect the downside or replace long positions with call options to limit the downside risk, increasing options premiums as the perception of higher volatility or “implied volatility” levels increases.
• Stable or bullish stock market trends encourage market participants to sell options. While some sell call options to increase the yield on holdings, others sell put options to collect premiums and buy stocks on dips at the options’ strike price.

The bottom line is implied volatility, and the VIX index tends to rise during selloffs and sharp corrections and fall when the stock market remains stable or rises.

The four current reasons for stock market volatility

In mid-May 2023, four factors support rising implied volatility over the coming weeks and months:

• The U.S. debt level: On May 16, the U.S. Debt Clock stood at nearly $31.75 trillion. With the Fed Funds Rate at a midpoint of 5.125%, the staggering debt will rise by $1.63 trillion yearly if spending and revenues remain balanced. Rising debt is a significant issue for the U.S. economy. While stocks tend to decline when interest rates increase, the increasing threat of an economic slowdown or recession is not bullish for stocks, and the S&P 500 and could cause sudden bouts of selling, pushing the VIX higher.
• The U.S. debt ceiling: The Biden administration and the slim Republican majority in the House of Representatives are at odds over increasing the current debt ceiling level. No increase by June 1 could cause the U.S. government to run out of funds to meet its debt obligations. The administration insists that Congress agree to raise the ceiling, while the Speaker of the House wants spending cut concessions. While the two sides will likely reach a compromise, it will only kick the debt can down the road for a limited time. Rising U.S. debt, high interest rates, and government spending will continue to be a hot-button political issue, with the threat of default hanging over the U.S. economy. A default would be devastating, as it could push the U.S. currency lower against other world foreign exchange instruments. Moreover, it could increase interest rates by sending bonds lower as it shakes the full faith and credit of the U.S. government, requiring it to pay higher interest rates to bond buyers.
• Geopolitical tensions: In February 2022, Chinese President Xi and Russian President Putin shook hands on a massive trade deal and a “no-limits” alliance. Less than one month later, Russia invaded Ukraine. Russia considers Ukraine western Russia, while the U.S. and Europe believe it is a sovereign Eastern European country. Meanwhile, China considers Taiwan a breakaway territory and has not been shy about its reunification plans. The bifurcation of the world’s nuclear powers has caused tensions to increase between Washington and Beijing. U.S. and European support for Ukraine has devastated any cooperation with Moscow. China, the world’s second-leading economy, has been negotiating trade agreements using non-dollar assets. The potential for a BRICS currency to rival the dollar as a global reserve currency threatens the dollar’s dominant worldwide role. The bottom line is that tensions threaten the U.S. economy and the dollar’s role in the global financial system, with significant ramifications for the U.S. stock market. Any surprise events that increase hostilities could cause a wave of selling in U.S. stocks, causing the VIX to spike higher.
• The current VIX level: At near the 17.50 level on May 16, the VIX was at the bottom end of the 2023 trading range. The VIX has traded between 15.53 and 30.81 in 2023. Risk-reward favors the upside at under the 20 level.

The bottom line is the stock market is too calm, given all the issues facing the worldwide economy and geopolitical landscape.

UVIX leverages the VIX

The fund summary for the 2X Long VIX Futures ETF product states:

UVIX holds derivatives that leverage the implied volatility of the S&P 500 for a single day. UVIX is a day trading instrument designed to mirror daily moves in the VIX index.

UVIX holds a leveraged long position in nearby VIX futures contracts.

At $10.19 per share on May 16, UVIX had $140.47 million in assets under management. UVIX trades an average of over nine million shares daily and charges a 1.77% management fee. UVIX is a volatile trading tool.

The two-year chart highlights the upside spike from August 2022 through mid-October 2022, when the S&P 500 dropped and the VIX rose from below 20 to nearly 35.

Since UVIX is a very short-term product using derivatives, time decay makes it a wasting asset.

The three-year chart illustrates the decay, and that timing is critical when using UVIX. Reverse splits that destroy value are likely when UVIX falls to low levels.

Accepting small losses in the quest for significant gains

Time and price stops are crucial components for success with the 2x Long VIX Futures ETF, which should never be considered an investment, but a daily trading tool. When using UVIX to profit from a rising or exploding VIX, be prepared to experience short-term daily losses. The optimal approach is to keep the losses under control with intraday time and price stops. The risk-reward plan should include accepting small losses in pursuit of substantial gains.

2x Long VIX Futures ETF is not a buy-and-hold instrument, as it requires active and constant management. Therefore, UVIX is never appropriate for passive investors. However, 2x Long VIX Futures ETF is a valuable tool for traders looking for a move higher in the volatility index who understand that risk of loss is always the price of the quest for rewards and timing and discipline are the keys to success.