In the continuation of the “Low Volatility is Not a New Normal” theme, Adam Samson of Financial Times published another post based on the recent report by JPMorgam which suggested using VIX options for managing the risks.
Risk assets, like stocks, have been rallying “for years”, sending market volatility near “record lows… While fundamentally volatility should not be high, it is clear to us that the current macro environment does not warrant all-time low volatility either.
The article concluded with a suggestion made by the JPM strategist.
For US equities, Mr Kolanovic suggests buying out-of-the-money call options on the Vix. The derivatives that are currently “close to their cheapest level over the last five years” would gain in value if the Vix rose over a pre-determined period and pay-out if the index hits a certain “strike” price. The same strategy can be used for the VSTOXX index, which provides a similar measure of implied volatility for the Euro Stoxx 50 that tracks eurozone blue chips. Read more
We believe that this suggestion is sound. However, it’s important to note that
- Just buying volatility when the VIX is low will not produce positive returns in a long run. But, if you have a large exposure to the US equity and want to buy VIX options as a hedge, then this is a sensible strategy. (If you have exposure to European markets, then VSTOXX futures and options are good alternatives).
- Buying volatility when it is low and rising will produce better returns.
- Before buying VIX options as a hedge, one should ask the questions: are they less expensive than SPX puts? Why do we buy VIX calls instead of SPX puts?
These questions should be addressed if we want to increase the efficiency of our hedging or trading strategy.