Stocks lost ground today, with the Dow Jones Industrial Average (^DJI -0.11%) and the broader S&P 500 (^GSPC 0.02%) declining 1.2% and 1.1%, respectively. For the S&P 500, it was the fifth consecutive daily decline, the longest such streak in three months.
Breaking the volatility addiction
In this morning's column, I noted that the VIX (^VIX 1.78%) rose above 20 yesterday on an intraday basis yesterday for the first time since July 25. (The VIX, calculated based on S&P 500 option prices, is a measure of the market's expectations for stock volatility over the next 30 days.) Today, it gained another 16.7%, to close at 22.72 -- its highest closing value since mid-June.
That "volatility of volatility" did not go unnoticed by speculators: Two of the 25 volume leaders in U.S. equity markets today were not common shares at all, but VIX-related exchange-traded notes (ETNs). All told, trading volume in the iPath VIX Short Term Futures ETN (VXX) and the VelocityShares Daily Inverse VIX Short Term ETN (NYSEMKT: XIV) amounted to roughly $1.5 billion -- a staggering amount for negative-sum investment products.
Individual investors should avoid trading these and other, similar products, which serve as a hot potato that the fast-money set pass back and forth among each other, their aim being to slice off a sliver of potato before they burn their fingers. That's before even mentioning the risks associated with the design and robustness of these products. In March, the relationship between a similar ETN, the VelocityShares Daily 2x VIX ETN, and its underlying index collapsed; as a result, investors suffered a stunning 50% decline over a two-day period.
Here's a good resolution for self-confessed investors: In 2013, I resolve to observe volatility, to take advantage of it when Mr. Market offers up good quality equities at a discount to their intrinsic value, but never to trade it.
