VIXM: Not A Hedge Anymore In The 0DTE Environment (2024)

Thesis

With some stocks exhibiting weakness on the back of weak consumer spending, it is time to visit potential structures which might hedge a portfolio. Starbucks (SBUX) reported a weak outlook on April 30th, causing its equity to fall -10% post-market, while McDonald's also warned earlier in the month that some consumers are stepping away from its products. Inflation is indeed percolating down, with some consumers preferring to prepare the same goods at home or go for much better priced alternatives.

The soft landing the market is pricing is not a given, and we might see bouts of volatility or the resurgence of a down move in equities. In this article we are going to have a closer look at ProShares VIX Mid-Term Futures ETF (BATS:VIXM), its composition and structure, and articulate our view on why the fund does not serve as a good long term hedge for a portfolio in the current 0DTE environment.

Fund composition - what are VIX futures?

VIXM contains a ladder of VIX futures:

As per ProShares:

VIX futures contracts give investors access to tradable S&P 500 volatility by providing a way to take a view on future values of the VIX. The price at which a VIX futures contract trades reflects the market’s view of the value of the VIX on the expiration date of the VIX futures contract.

The VIX is a volatility index on the S&P 500, and VIX futures are an easy way to speculate on future volatility for the equity market. Just like any other futures contracts, they have monthly expirations and experience decay.

An investor cannot directly invest in the VIX, they need to buy an ETF or ETN that either holds VIX futures or has a Total Return Swap with an investment bank that provides for a VIX linked return.

In the case of black-swan events, the VIX spikes, thus creating a positive total return for said investor:

If we look at the historical data for the past decade, we will notice a number of spikes above the 25 level, the most notable one during Covid. Usually the VIX trades in the 10 to 25 range in normalized economic times.

What are '0DTE' options and why are they important

As per Investopedia, the definition of 0DTE is:

Zero days to expiration options, or 0DTE options for short, are options contracts that expire and become void the same day that they’re traded.

Basically '0DTE's are put or call options which expire the same day. In 2022, 0DTE options on the SPX and SPDR S&P 500 ETF (SPY) were added for all five trading days. This was a game changer for volatility and we will show you why.

Instead of taking complex positions on vol, people were now able to speculate during the same day and receive a pay-out:

0DTE-s have now become widely popular, representing roughly 43% of the options market in 2023. You will notice SPY 0DTEs have been available since 2016, but only in 2022 did they become available every trading day, and thus became very popular.

0DTEs have put pressure on the traditional term volatility because the pay-out is instantaneous. Rather than wait for a tail event to be paid by the spike in VIX, people can bet intra-day on how the market will perform. The opening of this avenue has resulted in a suppression of volatility.

Suppression of term volatility

Let us see how the suppression of term vol works:

In October 2023 we had a -8% correction in the SPY and an increase in volatility. The VIX index though barely touched the 21 level prior to collapsing in the teens again. VIX futures reacted even less so:

From August 31, 2023 to December 1, 2023, the SPY ended up being fairly flat after a drawdown, all while VIXM lost -10%, while covering a 9% gain during the spike in vol.

The occasional spikes in the VIX are now shallow and reverse fast due to the 0DTE construct.

VIXM experiences decay because of its construct based on futures

We showed you above how VIXM is constructed, and how the VIX has been suppressed since the introduction of 0DTEs. Now we are going to talk about the decay present in VIXM and why in a normalized market environment it will decay significantly. Due to contango, the fund will experience roll decay in a normalized market:

The vehicle was down an eye-popping -44% in 2023, and even during the great market downturn of 2022 experienced a negative performance. Yes you read that correctly. Just look at the above table. Due to its composition, roll effect and 0DTEs, VIXM serves as a short term speculative tool rather than a portfolio hedge.

During 2022 when the SPY was down roughly -18%, VIXM failed to be a portfolio hedge. A hedge is a security which at the end of the year will provide a total return opposite the SPY. If the SPY is down, the hedge is up. Ideally in equal and opposite amounts. It is not the case for VIXM, and it will likely never be due to the above mentioned factors.

In our opinion this fund is best used by day traders or short term speculative ones, rather than traditional buy and hold retail investors. Prior to the volatility suppression introduced by 0DTEs the fund did provide for a hedge, as we can clearly see in 2018 when the SPY sold off furiously to end the year.

Retail investors looking for true buy and hold portfolio hedges are best served to look at names in that category we have covered before:

• Cambria Tail Risk ETF (TAIL) covered here
• AdvisorShares Ranger Equity Bear ETF (HDGE) covered here

These instruments are not based on VIX futures and provide for more appropriate buy-and-hold portfolio hedges in our opinion.

Conclusion

VIXM is a fund which is supposed to be a hedge when the S&P 500 falls. The ETF contains longer dated VIX futures, and provided for a robust return when Covid occurred. Due to the introduction of daily traded 0DTE-s in 2022, volatility is now suppressed, with funds as VIXM not being able to accomplish their goals in the same manner as before. VIXM exhibited a negative total return even in 2022 when the SPY was down -18%, all while the ETF lost -44% in 2023. The article highlights why in today's 0DTE environment funds like VIXM are not a portfolio hedging tool, but represent a speculative tool for very short term investors. The article also presents TAIL and HDGE as alternatives, names which have been covered by us before.

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