As election day slowly creeps up, investors should consider exchange traded funds that track the CBOE Volatility Index, or VIX, to hedge potential political risks, instead of relying on safe-haven plays like Treasuries or gold.
According to Cross Asset Solutions, volatility is the only investment that responds well to massive political shocks, reports John Waggoner for InvestmentNews.
“The market has always been complacent with political risk,” Florian Lelpo, head of macro research at Cross Asset Solutions and a co-author of the paper, told InvestmentNews.
The Cross Asset Solutions study tracked gold, stock volatility, foreign exchange, bonds and the U.S. dollar a month before and a month after the past six U.S. presidential elections since 1992, specifically looking for one-off market spikes.
“What you want in a hedge is a tent-like return: Positive before and negative after,” Lelpo said, noting that only equity volatility produced those results.
SEE MORE: ETFs to Hedge Election Risks Ahead
Currently, the financial markets are looking to a Hillary Clinton presidency but could react negatively with panicked selling should Donald Trump win out.
“When looking at the upcoming U.S. elections it seems only a few markets are pricing in the risk of an election surprise,” according to the study. “Current polls show Clinton leads by a large margin. However, as we have seen with Brexit, polls can misprice such events.”[related_stories]
Investors who are concerned of a potential upset may consider volatility or VIX exchange traded products to hedge against the political risks. The VIX, or so-called fear index, is a widely observed indicator for investor sentiment in the stock market and measures the expected or implied volatility of large-cap stock options traded on the S&P 500 index. ETPs that track VIX futures allow investors to profit during rising volatility or hedge against short-term turns.
For example, the iPath S&P 500 VIX Short Term Futures ETN (NYSEArca: VXX), REX VolMAXX Long VIX Weekly Futures Strategy ETF (BATS: VMAX) and ProShares VIX Short-Term Futures ETF (NYSEArca: VIXY) track short-term VIX futures. Potential traders should be aware that these VIX exchange traded products track the futures market and not the spot price of the VIX.
More aggressive traders have turned to the leveraged ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY), which provides the 2x or 200% daily performance of the S&P 500 VIX Short-Term Futures Index.
The VIX currently sits at 14.3, reflecting a rather complacent market. The index has reflected a relatively lax market for most of the year, compared to an average VIX value of 19.8 or a median value of 17.9 since January 1990.
For more information on the CBOE Volatility Index, visit our VIX category.