Economists warn that as the global economic recovery continues, it’s possible that markets and exchange traded funds (ETFs) could experience periods of volatility. With certain ETFs, you can help insulate yourself from such swings.
While ETFs that can be used as volatility hedges are welcome innovations, they do carry their own set of risks and drawbacks. [How the VIX ETNs Work.]
Ian Salisbury for The Wall Street Journal reports that there are two primary options when doing this:
- VIX ETNs. The VIX index is the market’s so-called “fear gauge,” which is calculated based on prices investors pay to buy and sell options on the S&P 500. The biggest risk with volatility-based ETNs is that because these securities’ returns reflect the cost of rolling futures contracts, long-term investors could see gradual losses, occasionally interrupted by sharp but temporary gains. iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) and iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ) are the two ways to get this exposure. [How to Hedge Market Volatility.]
- Short ETFs. The other way to harness the market moves is through bearish ‘short’ funds. Technically, these ETFs are designed to give -200% or -300% the market’s swings on a daily basis. Over longer periods, there is no guarantee that a bearish fund will give you that exact performance, and in volatile markets the risk of divergence becomes even greater. [Our Guide to Leveraged and Inverse ETFs.]
For more stories about volatility, visit our volatility category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.