VIX Portfolio Hedging (VXH) Strategy – Performance and Official Launch

Tue, Nov 16, 2010 | Jared Woodard

VIX Portfolio Hedging

The VIX Portfolio Hedging (VXH) Strategy is being offered to the public for the first time, starting today. The strategy is available via professionally managed accounts, or available by subscription here. First-time visitors may want to start with the previous posts on this strategy:

If your portfolio isn’t already protected against another major downturn, this may be a good time to consider your options. The costs of insuring a portfolio are lower now than they have been for the last several years, and the macroeconomic picture only seems to get cloudier as the months roll on. From the sovereign debt crisis in Europe to the municipal debt problems in the U.S., new problem areas continue to emerge even as policymakers attempt to address old concerns.

The VXH strategy provides effective portfolio protection at a fraction of the cost of other popular methods. In addition to giving investors exposure to long volatility products that profit when the market declines, the principal advantages of the VXH strategy are that it:

    1. incurs very low costs even during strong bull markets (cf. our analysis of how a VXH-hedged portfolio incurred no significant costs from 2006-2010, even after excluding gains from the financial crisis);
    2. requires a very small capital commitment as a percentage of the assets to be hedged under ordinary market conditions;
    3. uses a variable allocation method to apply protection when it is most needed: the variable method outperforms both diversified stock portfolios and fixed-allocation hedged portfolios;
    4. for larger investors, it is significantly less expensive to access than comparable offerings from major financial institutions and other advisors.

The chart below shows the combined hypothetical and actual performance of the strategy since 2006, applied to a core S&P 500 portfolio. The vertical red bar represents the August date upon which we began publishing the strategy for select clients.

For the statistically inclined:

The profits booked during the 2008 financial crisis were admittedly impressive, but I have tried also to emphasize the value of the VXH strategy in the absence of crisis conditions. Controlling costs during bull markets is, after all, nearly as important as protecting capital during bear markets.

Uwe Becker, the head of investor solutions and a managing director at Barclays Capital, recently noted that the expected cost of hedging using long-dated VIX futures contracts was recently as high as 2-3% per month, with a long-term average closer to 1%. Costs for short-dated protection are even higher than that, as investors pay more for contracts that will move more quickly in response to market changes. The rate for an S&P 500 variance swap expiring in June 2011 was recently above 28%; compare that with the 13% annualized volatility of the index to get a sense of how expensive protection can be.

The VXH strategy, by contrast, uses vehicles with a shorter-term focus (therefore providing more robust protection), but with a cost profile even lower than that of common long-dated instruments. The VXH strategy typically incurs monthly costs of less than 1% – again, excluding market environments in which the strategy yields substantial positive returns. Even during the unrelenting bull run of September – October 2010, for example, when the S&P 500 climbed 16%, VXH monthly costs barely crossed above 1%.

My research in this area has focused on keeping costs low and on using capital as efficiently as possible, and I think the VXH strategy is as effective and efficient as any other offering, if not more so. Please contact me with any questions about managed accounts or take a 6- or 12-month subscription to see how you can protect your own portfolio.

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4 Comments For This Post

  1. Aristotle Says:

    I check into your blog every so often. I just read all of your posts on this topic. Really interesting stuff. Is the hedging algorithn completely independent of the long portfolio’s volatility (beta)?

    IE would a portfolio that tracks the Nasdaq or R2000 be hedged with a different hedge %?

  2. Jared Says:

    Thanks for the comment. Yes, ideally a high-beta portfolio would be hedged slightly differently, and for managed accounts the initial consultation would address those details.

  3. Aristotle Says:

    Along the same lines, is the hedge $ driven at all by the size of drawdown you’re willing to accept?

  4. Jared Says:

    The base allocation algorithm is independent of any particular risk tolerance. But you can adjust those signals to your own risk preferences by changing the amount of capital available to commit to hedging and/or the size of the target portfolio to be hedged (which amounts to the same thing).

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More


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