*This article assumes the reader understands volatility funds, short selling, leveraged funds, and option trading.*
There are two major volatility ETNs (exchange traded notes), UVXY and VXX. Most people just assume UVXY is merely a 2x version of VXX, and not much else. Most traders who bet against volatility will simply short VXX without even considering UVXY, often because UVXY shares are ‘hard to borrow’, or they just figure UVXY and VXX are roughly the same thing, so what difference does it make?
As it turns out, shorting VXX is pretty bad strategy, mainly because VXX just doesn’t decay in a consistent enough manner. Although VXX was as high as 30,000 (split adjusted), and over the past eight years has decayed to its present price of 18 (for an annual compounded decline of 60%), there is more than meets the eye.
Let’s look at the past 5 years:
The astute reader may notice that for 21 months (between mid-2014 to early 2016) VXX did not decay at all. That’s pretty resilient for a fund that has lost some 99.94% of its value since 2009. Someone who shorts VXX in the hope of making a quick buck on what seems like surefire trade may be waiting a very long time (almost 2 years). That’s pretty bad. We can do better.
Let’s see how UVXY has done:
UVXY has decayed so much, I have to zoom-in. The longest it has gone without making a new low is about 10 months. This means even if your timing was as bad as possible, you only had to wait 10 month to make money, instead of 21 months. Way better. The reason why UVXY decays to quickly relative to VXX is due to the mathematics of leveraged ETF decay, which amplifies the contango effects by a factor to two, a well as everything else. When short-selling, the goal is to make money. Shorting UVXY accomplishes this goal far better than shorting VXX.
If UVXY cannot be shorted (due to fees or hard-to-borrow status), a simple way to bypass these problems is to sell the long-dated in-the-money call options on UVXY. Because UVXY is a 2x version of VXX, instead of shorting $4000 of VXX, one would short $2,000 of UVXY, which at a price of $20 as of 4/11/2017 means selling a single in-the-money call contract, which is a pretty good substitute for shorting 100 shares.
Short-selling UVXY has some added risks too (such as the leverage compounding effects working against you during extreme market volatility), but the trade-off is worthwhile.