Portfolio Protection: Long VIX
Nov 11, 2016
By: Sage Anderson
Despite the completion of the recent US Presidential election, there are still several big events that loom on the horizon before the end of the year.
The big item left in November is the OPEC meeting scheduled on the 30th of this month. The gathering was supposed to mark the official announcement of a coordinated production cut by some of the world’s largest oil producers. However, as seen through the big slide in oil prices over the last few weeks, there are now questions as to whether a deal will ultimately be agreed upon by that date (or any date for that matter).
December looks to be fairly interesting as well with the planned meeting of the US Federal Reserve falling on December 14th, as well as a referendum in Italy at some point before year end.
The extreme range observed in the S&P 500 during and after the recent US Presidential election may have been a signal that volatility could increase in the near term.
If you’re in that camp, you might be considering adding new positions that could potentially protect your investments in the event of a disaster. This would be especially relevant for traders focusing on short volatility and/or long equity strategies.
If you are exploring such protection, a recent episode of Closing the Gap may be a good starting point. The episode (titled: "Portfolio Hedge: Long VIX) focuses on why a VIX trade can make sense during periods of heightened uncertainty.
As outlined early in the show, the SPX and VIX have historically been inversely correlated. That means that as the SPX goes up, the VIX usually goes down, and vice versa. If your own portfolio outperforms when the SPX goes up (long equities or short volatility), you can therefore potentially exploit this relationship by deploying a protective hedge using the VIX.
Closing the Gap breaks the long VIX trade down into 5 easy steps and provides a detailed example for traders to review in the event they are considering this type of structure.
The five steps outlined on the show include:
Determine the portfolio's current market exposure
Choose how big a selloff to protect against
Calculate the corresponding move in the VIX and /VX futures
Choose the appropriate long VIX strategy
Size the trade to the desired potential protection
In order to get the best possible understanding of this trade, we recommend you watch the entire episode when your schedule allows.
It's important to note that while such a trade may protect your portfolio in the event of a selloff - the trade could lose money if the market sits still or goes higher.
If you have any questions on protective trade structures like the one discussed above we hope you'll follow up at firstname.lastname@example.org or leave a comment below.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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