The CBOE Volatility Index reveals a complacent market while the rally in equities has stretched valuations. For those who are wary about a swing in the market, consider hedging your position with VIX-related exchange traded funds.
BlackRock’s Chief Investment Strategist Russ Koesterich argues that price swings are likely to return, given the VIX is hovering near its record low this month and valuations are “stretched across markets,” reports Mary Childs for Bloomberg.
The VIX typically moves higher when stocks plunge. Investors would turn to S&P 500 options to protect their portfolios against any sudden dips.
The volatility index is sitting around a 11.5 and briefly touched 10.6, a seven year low, last week. Historically, the VIX has averaged around the 15 to 20 level. [VIX ETFs Reveal a Complacent Market]
Meanwhile, the S&P 500 index has gained 6.0% year-to-date and now shows a price-to-earnings ratio of 17.0. The index has not increased or declined over 1% in 48 sessions, the longest streak since 1995.
“Volatility is cheap,” Koesterich said in the article. While supportive global central banks policies has dampened volatility, “it’s not clear it should be this low,” he said.
Hedge funds have already increased bets on volatility. In listed contracts, demand for protection against a dip in the markets has sent the price on bearish puts to a 15-year high relative to calls.
BlackRock argues that a any changes to the Fed’s zero-interest rate policy could fuel volatility.
“The longer monetary policy smothers volatility and underwrites heady valuations, the bigger the eventual recoil,” BlackRock strategists including Koesterich said in a research note.
Investors interested in hedging against short-term dips in the equities market can take a look a couple of options. The iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), a VIX-related exchange traded note, and the ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) were both up about 1.1% Thursday, but the two funds declined about 32% so far this year.
Additionally, the more aggressive trader can consider the leveraged ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY), which tries to reflect two times or 200% the daily performance of the S&P VIX Short-Term Futures Index. UVXY was up 2.3% Thursday but down 59.7% year-to-date.
Investors need to keep in mind that these ETFs are designed to track CBOE Volatility Index futures contracts, not the VIX spot price. It’s a very important difference. [Father of the VIX Issues Warning on Volatility ETFs]
Volatility products are designed to “roll” the contracts over periodically to maintain exposure to VIX futures. They can lose money on this trade when longer-dated contracts are more expensive than the front-month contract, or when markets are said to be in “contango.”
For more information on the CBOE Volatility Index, visit our VIX category.
Max Chen contributed to this article.