VXX represents VIX future expiring just one month from today. That is because the VXX is the weighted average of its 1st and 2nd month VIX futures. For example at the renewal of the VIX futures you have 100% of 1st VIX futures and exactly one month left for them to expire, as every day passes you have less 1st month VIX futures and more second month ones, that is because every day a fraction of 1st month VIX futures are sold to buy 2nd month ones. So when you multiply the price of the 1st and 2nd VIX futures by their relative amounts you obtain exactly a weighted VIX value that represents a VIX expiring in just one month. You can find the dollar weights here (in the VXX data spreadsheet they are represented by the 1st and 2nd # of contracts):
Remember this: the VXX is the weighted average of the first two VIX futures front end months, weighted in such a way that they represent a one month VIX future. Therefore that is the number you should look at when trying to understand if the VXX is really high, low or normal. You do not have to only focus in its market value and historical performance because it is misleading due to the backwardation and contango effects, what you have to look at is at the weighted VIX.
How do you calculate that value: Easy! —> For example if the 1st VIX future is 18 and the second is 20 (VIX futures values are here) and you have 35% dollars of 1st VIX futures and 65% of the 2nd (VIX weights are here) then the weighted VIX is 1/(0.35/18+0.65/20) = 19.25, that value represents a VIX future expiring in just one month. In the spreadsheet the calculation is different because it works with # of contracts and not with dollar weights. As you see you can calculate it at any given time. If that number is quite below its historical average then you could say that the VXX is undervalued. So keep in mind that it’s not because the VXX fell a lot that it’s cheap, it could have fallen a lot but still not be undervalued if the weighted VIX is not significantly under its historical average. That is why that number is so important and the VXX market price should always be looked in relation to it.
This post was written inspired by someone who just asked me what the VIX weighted represented in the VXX spreadsheet:
2. What’s the purpose of “VIX Weighted”?
The post was my reply to his question, I think every VXX trader should know it.