by Michael Johnston on May 5, 2010 | Updated November 6, 2012 | ETFs Mentioned: AGG SPY VXX VXZ

As worries about a potential debt crisis in Europe boiled over on Tuesday, equity markets around the world plummeted in unison. Finding non-leveraged or non-inverse ETFs that didnt finish yesterdays session in the red was a challenge; only 14 components of the ETFdb 60 Index finished the day up. But amidst all the carnage. one exchange-traded product stood out, enjoying one of its best days of the year; the iPath S&P 500 VIX Short-Term Futures ETN (VXX ) gained more than 10% on Tuesday, rewarding investors who took out an insurance policy against a big uptick in equity market volatility (see Six ETFs To Watch As Greek Drama Unfolds ).

VXXs strong negative correlation with SPY has attracted a fair amount of interest from investors looking to add a diversifying agent to their portfolio. Most investors are familiar with the VIXa measure of the implied equity market volatilitybut some dont completely understand the risk/return profile offered by an ETN linked to a benchmark comprised entirely of VIX futures. VXX and VXZ (which is linked to the performance of longer-dated futures) are two of the most interesting exchange-traded products out there. But theyre not for everyone [see Free Report: How To Pick The Right ETF Every Time ].

How To Use Volatility ETNs

VXX is linked to the S&P 500 VIX Short-Term Futures Index Total Return. an index consisting of first and second month futures contracts on the Chicago Board Options Exchange Volatility Index, better known as the VIX. These contracts offer exposure to equity market volatility, as they generally tend to increase in value when uncertainty creeps into Wall Street. Generally speaking, a low value of the VIX indicates expected stability in stock markets, while a high value indicates expected turmoil. So when news of Greeces potential fiscal collapse breaks, volatility tends to spike. As such, the VIX generally exhibits a strong negative correlation with equity markets.

Since the end of January 2009 (when the volatility ETN products from iPath began trading), the S&P 500 SPDR (SPY ) has lost at least 3% in a single session nine times. During these trading days, the return on VXX ranged from 4.0% to 11.1%, with an average of 6.5%. The reputation of volatility ETFs as insurance against collapses in equity markets is well deserved, so for investors looking to protect against a big slide in prices, VXX is one of the best options available (because VXZ consists of longer-dated contracts, it tends to be far less volatile than VXX).

Better Than Bonds

Bonds have traditionally been embraced as an asset class that provides low correlation with equities, serving to smooth volatility in tumultuous markets. And indeed, bond marketsas measured by the iShares Barclays Aggregate Bond Fund (AGG )were in positive territory on the nine worst performing days for the S&P 500 since January 2009. But the biggest gain posted by AGG on these days was 0.6%, and the average increase was just 0.4%: