Ethan On A Tangent

VIX Hedging Amid Market Highs

Ethan Tang -

After the recent market surge from the "Trump Bump," I sought to protect my gains in equities against potential downturns, especially ahead of the inauguration. Noticing the VIX had fallen to $13.5—a relatively low point in recent years—I considered direct exposure to this volatility index.

Exploring Exposure Options

To my surprise, I found direct investment in the VIX Index isn't possible, but exposure can be achieved through:

  • Futures Contracts: Involves agreements to buy or sell the VIX at a future date.
  • Options: Provides the right, but not the obligation, to trade the VIX at a set price before a specific date.
  • ETFs and ETNs: Funds like VXX and VIXY track VIX futures, offering indirect exposure.

The Pitfall of VIX ETFs

Normally, I am perfectly happy purchasing ETFs that do all the work for me but examining VXX and VIXY revealed a significant drawback: both have declined over 90% in the past five years. This steep drop is due to the costs associated with rolling futures contracts, leading to value erosion over time. Holding these ETFs long-term would have been quite costly.

Opting for Options

Given the drawbacks of ETFs and deciding I only wanted enough protection while the VIX was low for the inauguration above, I turned to VIX options for downside protection. Strategies like purchasing VIX call options or setting up call spreads can hedge against market volatility. However, it's crucial to understand the complexities and risks involved in options trading which I'll touch on in the future.

Final Thoughts

There's no easy way to get direct exposure to the VIX and while VIX options offer a viable alternative to ETFs for hedging against market downturns, they require careful consideration and expertise.

Standard disclaimer to consult a financial advisor to ensure alignment with your investment goals and risk tolerance if you have no idea what you're doing.