Trading Fear: How to Trade the VIX

In a previous post, we discussed how to use the VIX Index to trade equities — particularly the S&P 500. But it’s also possible to trade the VIX directly using various financial instruments.

These trading vehicles come in the form of Exchange-Traded Funds (ETFs) and Exchange-Traded Notes (ETNs). Here’s what you need to know.

What Is an ETN?

An Exchange-Traded Note (ETN) is a type of debt security that trades on exchanges like a stock. It represents a promise from the issuer (typically a bank) to pay a return linked to a specific index or benchmark.

Unlike ETFs, which hold underlying assets (like stocks or futures), ETNs are unsecured debt instruments. This means their performance depends not only on the index they track but also on the creditworthiness of the issuer.

ETNs are often used to speculate on commodity futures markets (like oil or gold), but they’re also commonly used to trade volatility.

VIX ETNs: Trading Volatility Directly

Some ETNs are designed to track volatility futures, including indices that are either:

Long the VIX (they go up when the VIX rises), or

Short the VIX (they go up when the VIX falls)

There are also leveraged ETNs, which use derivatives to amplify returns — typically 1.5x or 2x the performance of the underlying index. For example, a 2x long leveraged ETN could gain twice as much as its non-leveraged counterpart when the VIX rises (but also lose twice as much when it falls).

Important Caveats When Trading VIX Products

There are two key risks when trading VIX-linked ETNs and ETFs:

Imperfect Tracking

These instruments do not perfectly follow the VIX itself. They often underperform during sharp VIX spikes, and their performance lags especially during volatile periods (see Figure 1).

Time Decay (Contango)

Because these products use futures contracts, they need to roll over contracts regularly — selling near-term contracts and buying later-dated ones.

When the futures market is in contango (where future contracts are more expensive), this leads to a gradual erosion of value over time — even if the VIX doesn’t move (see Figure 2).

⚠️ Long-term investors often experience losses from this time decay, which can be significant over months or years.

Figure 1. The VIX index (pink) and VXX (an ETN that attempts to track short-term volatility futures) over the past year. VXX grossly undershoots when the VIX spikes.

Figure 2. Time decay of VXX over the past five years due to contango.

How VIX ETFs Differ From ETNs

Both VIX ETFs and ETNs aim to provide exposure to VIX futures, but they differ in structure:

ETFs hold actual futures contracts (or sometimes S&P 500 options).

ETNs are debt obligations of the issuer and don’t hold any assets themselves.

As a rule of thumb:

The more complex the structure, the less precisely it tends to track the VIX itself.

Popular ETFs and ETNs That Track the VIX

Here are some commonly used products to trade the VIX, grouped by strategy:

🔹 Long VIX Exposure (rise in value when VIX rises):

XVZ — Tracks a broad volatility index

VXX, VIIX — Track short-term VIX futures

VXZ, VIXM — Track medium-term VIX futures

🔹 Short VIX Exposure (rise in value when VIX falls):

SVIX — Inverse exposure to the VIX

SVXY — Inverse exposure to short-term VIX futures

ZIV — Inverse exposure to medium-term VIX futures

🔹 Leveraged VIX Exposure (amplified movement, higher risk):

UVIX — 2x leveraged long exposure to the VIX

UVXY — 1.5x leveraged long exposure to short-term VIX futures

Using the VIX as a Contrarian Indicator

Many traders use the VIX as a contrarian signal — especially during spikes in volatility.

Historically, when the VIX spikes sharply, it tends to mean-revert rather than stay elevated. Traders can capitalize on this by shorting the VIX after a spike using short VIX ETFs or ETNs.

🧠 This strategy carries risk but can generate strong returns if timed correctly.

Using the VIX for Hedging

The VIX is also a useful hedging tool for equity investors. Since volatility typically rises when stocks fall, buying VIX-linked funds can help offset losses in a stock-heavy portfolio.

This is similar to buying insurance:

In most cases, the position will lose value slowly due to time decay.

But during a major downturn, the VIX spikes, and the hedge pays off.

🔒 Hedging with VIX products makes sense only as a protective strategy, not a long-term investment.

Final Thoughts

Trading the VIX is not the same as trading stocks or commodities. These instruments behave differently — often decaying over time, and they can amplify losses if misused.

Still, for active traders and sophisticated investors, VIX products offer powerful tools for:

Speculating on volatility

Short-term tactical trades

Hedging against market crashes

Always understand the structure, costs, and risks before entering a VIX-linked position.