Market Update: Hedge Your Portfolio Now with VIX Futures on the Cheap

Apr 28, 2017·Omer Rozen

While the stock market rallies in relief following the recent French election, trouble lingers both above and below the surface. Results of the election are positive for markets and U.S. earnings look bullish; however, Europe isn't out of the woods yet. Additionally, concerns about the economy are spreading, North Korea is unpredictable, and President Trump's impulsive decision-making process may lead to a catastrophe at any minute. Each of these issues has the capacity to create an avalanche in the markets, especially given the lofty valuations at which the market is currently trading.

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To hedge your portfolio against current and potential circumstances, I believe the VIX June contract provides the greatest value, as volatility for such a long-term period has rarely been this inexpensive. As the VIX is negatively correlated to any equity long portfolio, a 1% fall in the market may result in a VIX rise of approximately 5% or more, which would offset any monetary loss.

While hedging via $VIX (VIX), ETPs such as UVXY, and VXX (VXX) had catastrophic results this year as volatility collapsed. It is my view that buying the VIX June contact now with 57 days to expiration (currently trading at 13.05) seems like a no-brainer (irrelevant if markets continue to rise higher), as I believe that we may be able to assume that something will happen in the next 57 days that could make the June VIX rise above its current valuation.

The below chart that shows where VIX second contract – with 55-57 days to expiration – was trading at in January (14.18), February (14.53), and March (14.57).

VIX Futures Price Volitility

The past three months were characterized by extremely low volatility when markets made new highs and both the S&P and the Dow traded in tight ranges not seen since 2007. Things have started to look increasingly shaky for the White House administrations economic plans: concerns as to whether the economy will undermine current stock valuations started to surface among notable hedge fund managers; the timetable for tax reform, which would likely have a greater immediate effect on overall economic growth, seems highly uncertain; and North Korea seems prepared to start a nuclear war at any time.

It is my view that risk for this position exists but is very limited. Three of the last four VIX expires under 13, and an expiry below 13 will result in a loss. For that to happen, the stock market has to continue to rise, and any small losses from hedging will be highly offset by gains on long portfolio positions.

With all of this in mind, buying the June $VIX contract with 56 days to expiration at 13.05 could potentially be a low-risk, high-reward position, regardless of whether it’s for hedging or speculation.

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