How to Trade Volatility: Understanding the VIX and Why It’s Not Just a Hedge

This article offers a comprehensive guide to understanding volatility in the markets—specifically the VIX. It breaks down common misconceptions, explores the structure of volatility products like VXX, and explains why treating the VIX as a simple hedge can be misleading. Perfect for traders looking to deepen their knowledge and navigate volatility with more clarity and confidence.

What Is the VIX?

The VIX, also known as the “fear gauge,” reflects the market’s expectations for volatility over the next 30 days, derived from S&P 500 index options.

• Published by the CBOE

• Measures annualized implied volatility

• A VIX of 16.25 suggests ~1% daily market moves are expected

• It’s not a tradable asset, but futures, options, and ETFs/ETNs exist to rep

  licate exposure

This long-term chart shows the monthly price action of Cboe Volatility Index (VIX) Futures, highlighting key volatility spikes during events like the 2008 financial crisis, the 2020 COVID crash, and other market stress periods. Notice how volatility tends to revert to lower levels between major events, reinforcing the cyclical and reactive nature of the VIX as a market fear gauge.

How to Trade Volatility Using the VIX: A Tactical Approach

You can’t buy the VIX itself — but you can trade instruments that track VIX futures, not the index:

✅ Commonly Used VIX Exposure Tools:

• VIX Futures & Options – Direct access, but require margin and knowledge

• ETNs like VXX – Track short-term VIX futures (not the index)

• Leveraged ETFs like UVXY – 1.5x exposure to VIX futures

• Options on VIX ETFs – For advanced volatility positioning

⚠️ Important: These instruments don’t mirror the VIX directly — their behavior depends on futures curves, decay, roll yield, and path dependency.

VXX: From Market Darling to Portfolio Drag

After the 2008 financial crisis, ETF issuers capitalized on volatility fears by launching products like VXX — marketed as hedges or portfolio diversifiers.

But reality played out very differently.

📉 Long-Term VXX Performance

Year	SPY Return (S&P 500 ETF)	VXX Return (Volatility ETN)
2010	+15.06%	-72.23%
2011	+2.06%	-4.57%
2012	+15.84%	-78.12%
2013	+32.21%	-66.03%
2014	+13.53%	-26.16%
2015	+1.34%	-36.61%
2016	+11.80%	-68.10%
2017	+21.69%	-72.36%
2018	-4.38%	+14.76%
2019	+28.88%	-58.31%
2020	+16.26%	+34.42%
2021	+26.89%	-70.41%
2022	-18.11%	-48.73%
2023	+24.23%	-67.15%
2024	+14.34%	-61.29%

As seen above, even in volatile years like 2022, VXX often delivered negative returns due to contango and other structural headwinds.

🔄 Understanding the VIX–S&P 500 Correlation

One of the most well-known market relationships is the inverse correlation between the VIX and the S&P 500.

• When the S&P falls, the VIX often rises

• When the S&P rises, the VIX tends to fall

That said, the correlation is not perfectly inverse, and it can break down over short timeframes.

Key considerations:

• A sudden drop in the S&P typically causes a spike in VIX

• A slow decline might not move the VIX at all

• Sometimes, both can rise together — especially if implied volatility increases ahead of an event

The VIX reflects expectations of volatility, not actual movement. It’s forward-looking and influenced by option market flows, not just spot index prices.

This is why traders often say:

“The VIX is its own market.”

This chart illustrates the inverse relationship between the S&P 500 (black line) and the CBOE Volatility Index (VIX) (red line). Notice how spikes in the VIX often align with major market bottoms (green circles), highlighting volatility's tendency to surge during market stress. The "Capitulation Zone" shows typical levels where fear peaks and markets often begin to recover.

What Are Contango and Backwardation?

• Contango: Futures are priced higher than spot — common in calm markets. Long volatility products lose value as contracts are rolled forward.

• Backwardation: Futures are cheaper than spot — occurs during volatility spikes. Short-term benefit for long volatility exposure.

VXX’s long-term underperformance is primarily due to contango. It’s a drag on returns, especially in sideways or bullish markets.

This diagram illustrates the difference between contango (red curve) and backwardation (green curve). In contango, future contract prices are higher than the current spot price—common in calm markets. In backwardation, future prices are lower than the spot price—typically during periods of market stress or anticipated volatility. This pricing structure plays a key role in the performance of volatility products like VXX.

The 2018 Volatility Spike: A Turning Point

In February 2018, VIX spiked 100%+ in a day. While VXX jumped, many traders using inverse products like XIV were wiped out.

• Retail traders who were short volatility suffered massive losses.

• Market participants learned (some painfully) that volatility can be path-dependent — a rise in the VIX doesn’t always correspond to expected portfolio outcomes.

Barclays Redesigns VXX

In 2019:

• Barclays delisted the original VXX.

• It was replaced by VXXB, later renamed back to VXX.

• A redemption clause was added: Barclays could close the ETN and return cash to holders — protecting themselves from structural risk.

From launch to its final close, VXX lost over 99.99% of its value. A $1M buy-and-hold would have become less than $100.

Mindset Shift: Volatility Is an Asset Class

Here's a mindset shift that changes everything:

Don’t treat volatility as a tool. Treat it as an asset class.

Like currencies or commodities, it has:

• Its own structure

• Unique drivers (e.g. hedging demand, positioning)

• Complex instruments tied to expectations, not just outcomes

You can’t simply expect the VIX to spike whenever the market falls — nor can you expect VXX to hedge your portfolio reliably.

How Volatility Is Used by Some Market Participants

Rather than treating VXX as a hedge, some traders use volatility instruments as short-term tactical tools to manage event risk or dislocations.

For example:

• Positioning with VIX call spreads around key macro events

• Adjusting exposure during known volatility catalysts

• Using volatility structures to balance portfolio convexity

These approaches typically involve:

• Defined timeframes

• Measured ratios

• Deep understanding of term structure, roll risk, and settlement mechanics

⚠️ Common Pitfalls to Avoid

• Thinking VXX = VIX

• Buying VXX as a long-term hedge

• Ignoring the futures curve

• Trading without understanding path dependency

Even when the market behaves “as expected,” volatility products may not.

✅ Summary: What to Remember

• The VIX measures expected volatility — not direction.

• You can’t trade the VIX itself — only futures and derivative products.

• Long VXX exposure is structurally disadvantaged in contango.

• Volatility trading is best approached as a separate strategy, not a simple hedge.

• Education and understanding of the mechanics is essential.

🧠 Final Thought

Trading volatility isn’t about guessing where fear is headed — it’s about understanding how the volatility market is structured, and how these products actually behave.

With the right knowledge, it becomes a powerful addition to your toolbox.

Without it? You're just donating money to the market.

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Disclaimer:

The information contained in this article is provided for general informational and educational purposes only and does not constitute financial, investment, or other professional advice. The content reflects the personal opinions of the author based on publicly available information at the time of writing and should not be relied upon as the basis for any investment decisions. Earnings reviews may contain forward-looking statements that are inherently uncertain and subject to change.

Readers are strongly encouraged to conduct their own research and due diligence, and to consult with a qualified financial advisor or licensed professional before making any investment or trading decisions. The author and publisher make no representations or warranties, express or implied, as to the accuracy, completeness, or reliability of the information provided and accept no liability for any loss or damage arising directly or indirectly from the use of or reliance on the information herein.