Here we are only a few short days since offering to investors the potential with ProShares Ultra VIX Short-Term Futures ETF (UVXY). Despite the vast majority of publications insinuating or offering directly to buy volatility and/or VIX-leveraged ETFs/ETNs, shares of UVXY and TVIX are hovering at all-time low trading prices. In a recent Seeking Alpha article titled “VIX Update: VIX Still Ready To Rise”,the author promotes buying volatility-related instruments. While this article was published only a week ago, the same author has been promoting the acquisition of volatility related ETFs/ETNs since October as highlighted in the article “VIX Update: Contango Narrows”. 

While Chinese data provides a mixed picture, the put to call ratio coupled with the upcoming U.S. election, a rising U.S. Dollar Index, higher expected interest rates, topping oil prices and stretched equity fundamentals provide a backdrop that is likely favorable towards rising VIX levels and a declining S&P 500 Index. Earnings season will impact stocks, but as earnings are expected to decline by 2.1% for the third quarter, the impact will probably be negative on the whole. Given this combination of data, a long VIX or short S&P 500 strategy remains attractive in the near term. With the VIX futures curve contango narrowing, I continue to highlight long VIX opportunities in VXX, UVXY and TVIX as well as their options and VIX futures.

Moreover, the bullish/long volatility and VIX-leveraged ETF article continue to proliferate.  Below are a couple, more recent VIX, long-biased articles:

• VIX Peaks: A Trend Reversal Is Finally Here 
• Trading VIX Update - SVXY And XIV Will Outperform Markets Through Year-End 

A quick check on the prices for these ETFs/ETNs from October through today shows a strong deterioration in price. I certainly don’t offer this retrospective to dismiss someone else’s investing ideas or acumen, but the VIX and VIX-leveraged products are not meant or constructed to be bought for long opportunity. The nature and natural disposition of volatility is to remain in a state of complacency longer than it exhibits extreme volatility.   And that is exactly how it behaves and has been portrayed in VIX-leveraged instruments.  In laymen’s terms, if volatility continuously outperformed, there would be no such thing as a stock market to produce volatility from.

Can you make a few bucks going long VIX and VIX-related products, certainly! But you had better have really good timing on both your entry and your exit for it to be a meaningful risk/reward venture! As a discipline, however, timing is not usually a long-term, profitable strategy.  More often than not, trading based on timing with early success leads to long-term losses of capital for many traders/investors. The best strategy when investing capital is to invest based on the fundamentals of the equity of consideration.  The fundamentals for UVXY and TVIX are such that they have been constructed to decay in price long-term. I recently explained this fundamental decay in price in an article titled “Contango Spreads Across ProShares Ultra VIX Short-Term Futures ETF (UVXY)”.    

Besides the construction of the ETF’s that ensures long-term share price decay, the element of contango adds another layer of certainty for those who short UVXY. Contango is the defined condition occurring when VIX futures that underlie these ETFs are in price/time arrangement and as such contribute to the share price decay. When the level of contango increases it also exacerbates price declines, even during periods where the VIX actually rises. In more laymen terms, when contango takes over a share price death spiral takes place in the VIX leveraged ETF until the share price exhibits a reset. The reset occurs with an authorized reverse split.

You’ll notice the price of UVXY was significantly higher when this article was published.  This is because contango further widened and exacerbated price decay.

With regards to volatility and VIX-leveraged ETFs/ETNs, it is imperative to understand the best positioning for these instruments is from the short side and for all the aforementioned examples and reasons. Furthermore, the articles examples regarding going long such instruments don’t take into consideration one very, very important variable.  Allow me to explain…

In previous articles, I denoted the decay in UVXY and TVIX were perpetual and based on the construction of the instruments as well as the nature of volatility. In addition to these articulations, I offered the defining characteristic of contango and how it behaves as a catalyst to the price decay of these instruments. At this time what I’d like for readers/traders/investors to consider is the inevitable situation that produces a reverse split for UVXY and like instruments. The reason it may be optimal to have this discussion presently is two-fold:

1. Longs seemingly only consider very low VIX and UVXY prices as reasons to be bullish or go long. 

2.  Long-biased VIX and/or UVXY publications don’t offer what one should consider in the event of a reverse split. 

So what do you have to consider when going long UVXY at all-time low trading prices that produce a reverse split? MORE CASH!! If you went long shares of UVXY before the ETF executed a reverse split, you already find yourself underwater and likely by double-digit percentage points. Moreover, you just watched your share count dwindle. (Likely 5:1 split based on history) As such, your shares have to work that much harder just to get back to break-even on your trade. More than likely one will force the matter and dedicate more capital to the trade to increase share count/exposure, hoping for a near-term price appreciation at an improved cost average basis. This demonstrates the need for more capital, but it is also why so many traders from the long side wind up losing that much more capital. I hate seeing it happen, but I literally see it happen prior to every single UVXY reverse split. 

So with all the calls for a VIX bottom and bullish, VIX-leveraged ETF articles proliferating for weeks now, UVXY just hit another all-time trading low on December 5, 2016, today! I’m not saying UVXY won’t ever rise in price, but rather the most comfortable and fundamentally proven strategy for utilizing UVXY comes from shorting such price appreciations.