I like to tell investors that if you’re not hedged somehow against the possibility of a stock market crash, you’re basically having unprotected you-know-what… every day… with strangers… with terrible reputations.

Since I’m fairly certain that you have no interest in unprotected investing – especially in a decade-old bull market featuring stretched valuations, a global economic slowdown, and a President and Fed Chair who don’t really like each other very much – it’s natural to seek ways to hedge against a potential Minsky moment.

Volatility exchange traded funds (ETF’s) and exchange traded notes (ETN’s) are a popular method of tracking the VIX and thereby owning an asset that will go up if the stock market goes down. So, for instance, if your portfolio has 60% blue-chip stocks and 40% volatility ETF’s/ETN’s, a market crash would be less painful because your ETF/ETN holdings would increase sharply in value.

Today, as I write this, we’re seeing a perfect example of this in action: the S&P 500 closed down 0.78%, and the VIX (the volatility index or “fear gauge”) increased by 8.32%. VXX, the VIX-tracking ETN which will soon “mature” and be replaced by VXXB, fared nicely today:

Courtesy: Yahoo Finance

This type of performance is typical on trading days with moderate volatility in the S&P 500; heavy volatility can cause VIX ETF’s/ETN’s to shoot up 25% or more in a single day. It’s enough to seduce plenty of speculators: the average daily trading volume of VXX, for example, has been in the tens of millions for years.

It’s also enough to convince concerned blue-chip investors that VIX ETF’s/ETN’s are a good alternative to precious metals as a market crash hedge. And while it’s undeniable that popular VIX tracking assets like VXX/VXXB (which is unleveraged) and TVIX and UVXY (which provide leveraged VIX-tracking exposure) can provide impressive returns on volatile trading days, are they worth buying and holding as a form of crash protection?

Unless you have a working crystal ball or unbelievably good timing, the answer is a decisive “no.” VXX/VXXB, TVIX, and UVXY suffer from a futures trading phenomenon known as contango, in which the managers of these assets are forced to constantly sell VIX futures contracts prior to expiration at a lower price and buy future-month futures contracts at a higher price.

In other words, in order to continually have VIX futures contracts in their inventory, the asset managers are required to sell low and buy higher – a formula for disaster over the long term, even while there will be extremely lucrative volatility spikes from time to time.

Let’s see what this looks like for the three most well-known long VIX assets. First is VXX (which, again, will be replaced by VXXB any day now):

Courtesy: barchart.com

Yes, you’re reading that chart correctly: VXX has literally gone from six figures to under $40 per share. Granted, there has been a historic bull market since 2009, but the decline in VXX has been breathtaking compared to the S&P 500’s relatively tame 300% increase during that time. 

And that’s the unleveraged VIX product. Consider how much worse the leveraged VIX products have performed – we’ll look at TVIX first:


Courtesy: barchart.com

If you had Nostradamus-like timing and bought TVIX shares right before the 2011 European debt crisis, and then sold them immediately afterwards, you would have done extraordinarily well. For the rest of us mortals, getting wiped out would have been the inevitable conclusion.

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    Just to be a completist – and, more honestly, to satisfy my morbid sense of schadenfreude – let’s also take a look at UVXY’s performance over the years:

    Courtesy: barchart.com

    From over a hundred million dollars per share to sixty bucks and change – not what I would call an ideal crisis hedge. Personally, I’d rather choose an asset that’s been around for 6,000 years and has performed well since 2009, and since 2000, and on many other time frames:

    Courtesy: barchart.com

    For enduring value as a stock market crash hedge, you’ll be hard-pressed to find anything as good as gold. Even if you’re the anti-Nostradamus and bought exactly at the 2011 peak, I firmly believe that you’ll do well if you just hold your gold.

    As for the long volatility funds, I’ll leave that to the day traders and speculators with cash to burn. Meanwhile, I’ll be sleeping soundly at night – with my crash hedges stored in a secure location, ready for whatever may come.

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