The final presentation I attended at this year’s Risk Management Conference discussed Hedging with VIX. Pravit Chintawongvanich, Head of Risk Strategy at Macro Risk Advisors covered different methods of hedging a portfolio using VIX.
Pravit began listing several questions that should be addressed to determine what will be the ‘best hedge’. Examples of these questions include what type of sell-off are we concerned about or what is the potential timing of this move.
He compared hedging with either S&P 500 Puts or VIX call options. He noted, that if the S&P 500 rallies, puts may become so far out of the money which would make them irrelevant as a hedge. Conversely, VIX has a bit of a floor which means VIX calls may remain ‘in play’ even if the equity market has rallied. He also noted that depending on the strike prices, S&P 500 puts may be more reactive relative to VIX calls in a market sell-off and are a more direct hedge than VIX calls.
A comparison of VIX futures versus VIX calls was offered up as well. Pravit noted that VIX options are priced off VIX futures and the roll down of VIX futures pricing results in the underlying moving away from the call strike price. He noted that VIX futures already have an option like payoff so buying VIX calls is like buying calls on calls. One time when VIX calls will outperform is when we get a big spike in volatility. With respect to monetizing a VIX hedge Pravit noted that VIX calls can deteriorate very quickly after an initial VIX spike.
A final comparison involved looking at VIX calls spreads versus looking at buying VIX calls. Pravit noted that in order to realize the full value of a call spread you need to hold it to expiration. The short option in the call spread is a drag in performance and monetizing the spread would result in a fraction of the maximum potential return. However, if you plan on holding the trade through expiration the call spread may be a better trade.