If you want exposure to the “Fear Index” or the CBOE Volatility Index, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) might be your best bet. It’s a complex exchange-traded note (ETN), however, so you need to know the basics before you look to trade it.

VXX explained

The VXX trades like an exchange-traded fund but it also has some bond-like qualities stemming from the fact that it’s an exchange-traded note. Although VXX can be bought, shorted or sold at any time from pre- through post-market, you own the note and not any underlying assets. As a result, you shouldn’t stick to the fundamentals when trading volatility.  

The value of VXX is based on supply and demand of the notes, but it tracks closely its underlying index, the S&P 500 VIX Short-Term Futures Index, which “holds” a hypothetical portfolio of the two nearest-to-expiration S&P 500 VIX futures contracts.  The underlying index is designed to provide access to equity market volatility through VIX futures, and therefore, the ETN provides exposure to the movements in the VIX. Keep in mind that the underlying index specifies a new combination of VIX futures in that hypothetical portfolio, on a daily basis.  

More specifically, the underlying index offers exposure to a daily rolling long position in first- and second-month VIX futures contracts. This reflects market participants’ current views of the future direction of the VIX index when the VIX futures contracts comprising the index expires.

The bottom line

Although you’ve gotten the basics of the iPath S&P 500 VIX Short-Term Futures ETN here, there’s more due diligence to complete. Look at the VXX website, and examine a prospectus to get a more in-depth look at the intricacies of this ETN.

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Jeff Bishop is lead trader at TopStockPicks.com. He runs short-term trading strategies, using stocks, options and leveraged ETFs.

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