Monday, May 17, 2010
Hedging Equities with Volatility
The recent pullback in capital markets sparked by fears of a debt-ridden Eurozone collapse demonstrates the need to be hedged against market volatility. One of the ways to accomplish this is to simply purchase long positions in the VIX during periods of hope and complacency.
The VIX volatility index rises during periods of fear, panic, and uncertainty, and falls during periods of hope, greed, and stability. Since the VIX will never fall to zero, purchasing long positions in the VIX when it is low is a relatively safe strategy. Conversely, since the VIX is not a value-producing asset, it must be actively traded, and therefore it must be sold when volatility spikes and fear returns.
We recently used this strategy with some success. On February 26 2010 we entered a long position in the VIX via the VXZ exchange-traded note. The entire position was sold on a panic volatility spike which occurred May 7 2010. The trade yielded a 25% gain over 6 weeks, which provided a welcome hedge against the degradation of long positions over the same time period.
The VIX volatility index rises during periods of fear, panic, and uncertainty, and falls during periods of hope, greed, and stability. Since the VIX will never fall to zero, purchasing long positions in the VIX when it is low is a relatively safe strategy. Conversely, since the VIX is not a value-producing asset, it must be actively traded, and therefore it must be sold when volatility spikes and fear returns.
We recently used this strategy with some success. On February 26 2010 we entered a long position in the VIX via the VXZ exchange-traded note. The entire position was sold on a panic volatility spike which occurred May 7 2010. The trade yielded a 25% gain over 6 weeks, which provided a welcome hedge against the degradation of long positions over the same time period.
