Look at this baby. It looks like it can keep on going down so much that is it going to go under zero.
Here we are looking at VXX, the Barclays Bank PLC iPath S&P 500 VIX Short Term, the volatility ETF that can’t seem to keep its wings up. The only reason it is still tradable is because of the VXX reverse split that Barclays has to do every so often.
We recently wrote a post on the UVXY reverse split, and we will continue our coverage of reverse splits here today by talking about the VXX reverse split.
What is VXX?
VXX is a way for Barclays to make money and a way for investors to get exposure to trading volatility. Because trading the VIX is not as easy as people think, a lot of people turn to an ETF like VXX in order to trade the rise and fall of volatility.
VXX is actually incredibly popular.
Over the last 50 trading days, VXX averaged 41,503,933 shares traded per day. With a current price of $16.92, that would mean the average notional value exchanged for VXX stock on a given day is around $702,246,546.36. I’d say that makes it pretty popular.
The options markets also trade with crazy volume. As off 3:30 today, VXX had traded
210,128 options contracts. This means there was a total notional value exchanged for VXX options today of $355,536,576 thus far. Obviously, institutions are playing VXX with these kinds of numbers.
How is the Price of VXX Calculated?
The way the price of VXX is calculated by Barclays is the same reason why we will see another VXX reverse split. Let me explain…
Barclays is responsible for managing VXX. In doing so, they have a set number of VIX futures contracts that set the price of VXX. Like all futures, VIX futures all have expirations dates.
If there are VIX futures contracts being held by VXX (Barclays) and those contracts are expiring soon, Barclays will have to sell those futures and buy other ones that are further away from expiring.
One of the problems with this is that VIX futures contracts are in contango 80% of the time. What is contango you ask? It is the concept that prices of the VIX futures further away from expiring are higher priced than the ones closest to expiration.
If Barclays is sitting there today and going, “Jolly! We have 10 /VZH7 futures that expire in 8 days. We have to get rid of them and get some new ones!” In reality, they will not be happy with this. Why might you ask?
Mr. Barclays has to sell his 10 /VKH7 VIX futures for $12.55 a contract and at the same time buy 10 /VX13H7 contracts for $13.10. They are selling something that is lower priced than what they are buying, AKA taking a loss. How much of a loss would it be in this scenario?
There is a $0.55 cent difference between the contracts which for a VIX future is $550 per contract. Multiply that by 10 contracts and we get a loss on that roll of $5,500.
So why does VXX seem to never go up? Because this phenomenon happens 80% of the time. So when the VIX is flat, VXX is down because of the negative drag contango makes.
Why Do We Have A VXX Reverse Split?
A VXX reverse split is necessary to keep VXX a tradable product. Otherwise, it would go to zero or trade for fractions of a penny which means it would no longer be listen. nDuring a reverse split, shareholders are given less stock in exchange for a higher price. Nobody is going to be interested in a stock that is trading for $0.10. So Barclays goes ahead with these reverse splits to maintain liquidity in their product thus, continue to make money. Since there will be a VXX reverse split in the future due to the contango in the futures market, let’s take a look back and the four times this occurred.
Let’s look at an example of what would have happened if we had 100 shares of VXX on November 7, 2013 before the third VXX reverse split and then on November 8, 2013.
That is how a reverse split works folks. We trade in amount of shares for share price to keep the engine running.
What To Do?
We now know the following about the VXX reverse split:
- It is necessaary to make the stock tradable
- We exchange share count for share price
- Contango causes a negative drag to VXX 80% of the time
Now that we know this…what do we do?
Well for starters, we never ever get long VXX. Why would we buy something in the hopes for an up move if it has a negative drag against in 80% of the time?
We wouldn’t! And not that you know this, I’m sure you won’t either!