UVXY: It's Just Not Worth The Risk (BATS:UVXY) (2024)

As you can see in the following chart, the ProShares Ultra VIX Short-Term Futures ETF (BATS:UVXY) has taken a sizable hit in the wake of the election with shares sitting near multi-month lows.

While some may be tempted to try and pick the bottom in this ETF, I would suggest that this is the bad idea. Specifically, I am quite bearish UVXY and believe that the ETF is headed lower in the coming weeks and months.

About UVXY

To start this piece off, let’s take a look under the hood at exactly what UVXY is and does. From its headline, investors may be tempted to believe that UVXY is simply a leveraged play on volatility but as you’ll see in this section, that simply isn’t the case. UVXY is a fairly complicated ETF which is following a very problematic index which has simply shredded shareholder value through time.

UVXY is an ETF which is tracking the S&P 500 Short-Term VIX Futures Index on a 1.5x leveraged basis. This index is provided by S&P Global and it relatively straightforward: it holds a basket of first and second month VIX futures such that the average holding is 30-days into the future. How the math basically works out is that you will start a month holding 100% of the front month VIX futures contract and end a trading month holding 100% of the second month VIX futures contract. To see where UVXY is at any time in its rolling cycle, you can reference its table of holdings.

While the rolling process may seem complex, this is a relatively straightforward methodology for holding VIX futures.

The problem with this methodology is quite simple: it loses an outstanding amount of money for its followers through time.

In the above chart, I have graphed the historic performance of the index that UVXY follows. Put simply, this chart shows a very large degree of losses, with unleveraged shareholders losing value at around 47% per year for the past decade. Keep in mind that UVXY is giving a 1.5X return of this index, so back-of-the-envelope math would say that if you would have followed UVXY for the past decade, your annualized loss would be in the realm of 70% per year.

It’s hard to see in the above chart, but the consistency of losses experienced by UVXY’s methodology is actually quite noteworthy: put simply, the longer you hold, the greater the odds that you will lose money.

In this chart, I’ve calculated the historic probability that UVXY’s methodology delivered losses over a certain holding period. For example, for the past 10 years, UVXY has lost money in 72% of all months. And the longer you hold UVXY, the odds just tend to keep increasing. For example, 90% of all 12-month periods have experienced losses.

Another way of looking at the data is to simply examine the 1-year percent change in this index through time.

As you can see, there have only been a few brief periods of time in which investors could have held UVXY for 1 year and actually made money. The odds are pretty firmly against the bulls in UVXY.

Okay, but what is driving this? The data clearly suggests that something is seriously off beneath the surface of this ETF’s methodology, but it doesn’t tell us why the relationship is playing out with such consistency. While we certainly can make money off of observed relationships alone, understanding the underlying “why” behind the data adds the most value, in my opinion. This key reason of consistent losses is due to a few nuances regarding VIX futures contracts and how they price.

If you recall, UVYX is actually investing in VIX futures, not the VIX itself. This is a very important distinction to make because at any given point, when you hold UVXY you are holding a basket of futures which will be settled against the VIX’s level at a future date.

The problem with holding VIX futures is that they tend to be priced above the spot level of the VIX. For example, for the past 10 years, the front month VIX futures contract has been above the spot VIX in about 85% of all days. And the key issue here is that futures converge to spot. In other words, at the time of settlement of any specific futures contract, it will move to match the VIX level. And since futures are generally above spot, this means that futures are generally falling towards the spot VIX.

VIX futures contracts settle off of whatever the VIX is at the time of expiry (with some nuance behind the scenes). This essentially means that if you buy a futures contract which is priced above the spot level of the VIX, then your futures contract will gradually decrease in value until it equals the spot price at around expiry (all else equal). Here’s a chart showing this relationship at work.

In this chart, I have gone back over the past 10 years and calculated the average level of VIX futures contracts and the VIX itself by the number of days until expiry of the front month contract. This chart shows a remarkably clear relationship:

• On average, VIX futures are priced above the spot level of the VIX. And this degree of difference between the spot level increases with duration – longer the time until expiry, greater the value above the spot VIX.
• On average, VIX futures slowly converge towards the spot price in a typical month, with the front month contract reaching parity at expiry.

It’s impossible to overstate the importance of this chart for understanding what’s really happening beneath the surface in UVXY. With the ETF, you are starting the month holding the front month VIX futures contract (“Month 1”) and ending the month holding the second month contract (“Month 2”). See the problem?

The key problem here is that since UVXY is holding these futures contract which are heavily exposed to convergence, it is consistently losing money. For example, as we have already discussed, a strong 72% of all months see losses – and the odds of losses just increase with holding duration.

For this reason, I suggest that investors avoid UVXY or look for shorting opportunities using options. I currently own puts on this product because the numbers are fairly clear: UVYX consistently loses money for anything but the shortest-term investors. In light of the data, I believe that a bearish bias on UVXY is the most appropriate play.

Conclusion

UVXY is following a methodology with a demonstrated history of eroding wealth. The data shows that on average, UVXY would have lost investors about 70% of value per year. Roll yield remains the primary explainer of long-term returns in UVXY and why investors should avoid this product.

I work within the trading and money management industry. I have been trading and investing for several years. My style is technical execution with a fundamental thesis in place. I rely heavily on statistical analysis of the correlations between fundamental changes and price movements for generating most ideas.