CBOE VIX Tail Hedge Index (VXTH)
CBOE is introducing a benchmark index designed to cope with extreme downward movements in stock indexes -- the CBOE VIX Tail Hedge IndexSM (VXTHSM).
The VXTH Index tracks the performance of a hypothetical portfolio that -
- Buys and holds the performance of the S&P 500® index (the total return index, with dividends reinvested), and
- Buys one-month 30-delta call options on the CBOE Volatility Index®(VIX)®. New VIX calls are purchased monthly, a procedure known as the "roll." The weight of the VIX calls in the portfolio varies at each roll and depends on the forward value of VIX, an indicator for the perceived probability of a "swan event".
- The weights are determined according to the schedule below and the weights applied at a particular roll date can be seen by opening the VXTH Monthly Roll Spreadsheet at http://www.cboe.com/micro/VXTH/
The power of the VXTH index comes from the exceptionally high returns garnered by VIX calls in times of steep stock market declines. This means few VIX calls need to be purchased. To further increase efficiency, the VXTH is carefully calibrated: the weight of the VIX calls in the portfolio varies at each roll depending on the likelihood that a "black swan" event is about to occur. This has the effect of reducing hedging costs and monetizing VIX option profits when extreme volatility levels are reached. This monetizing of the VIX option position in turn means that overall capital can be preserved.
Paper on Hedging and Tail Risk Management
Key Tools for Hedging and Tail Risk Management is a paper by Asset Consulting Group (February 2012)
Key highlights from the paper include:
- Tail Risk Over 25 Years: Since mid-1986 the worst monthly declines for select indexes include: down 28.2% for the S&P GSCI Index, down 21.5% for S&P 500, down 20.2% for MSCI EAFE, and a decline of only 8.6% for the CLL Index (Exhibit B).
- Risk and Diversification in 2008: Changes for indexes in 2008 - S&P 500® down 37.0%; two indexes with options and stocks - CLL Index down 23.6% and VXTH Index down 19.3 (Exhibit A).
- Lower Volatility: The CLL has incurred about 70% of the volatility of the S&P 500 over the last 26 years. Select portfolios with the VXTH had less volatility than the S&P 500 over the last 70 months (Exhibits C, F, and O).
More papers and benchmark index information are available at http://www.cboe.com/benchmarks
- Clary, Isabelle. "Managers Turning to Futures, Options to Counter Volatility." Pensions & Investments (March 31, 2008).
- Cui, Carolyn. "Commodities Zig; Stocks Do, Too; Parallel Drops Undermine Oil and Grains In Their Roles as Alternative Investments." Wall Street Journal (Oct 17, 2008). pg. C.1.
- Farrell, Christopher. "Protecting Your Nest Egg In Volatile Times." Business Week (Oct 27, 2008) pg. 73.
- Farrell, Maureen. "Protect Your Tail." Forbes (June 8, 2011).
- Lauricella, Tom. "No Diversification: How Bond Funds Let Investors Down."
- Wall Street Journal (June 1, 2009) pg. R.1.
- Leibowitz, Martin L. and Anthony Bova. "Diversification Performance and Stress-Betas." The Journal of Portfolio Management (Spring 2009).
- Lim, Paul. "25 Years of Conventional Wisdom, Down the Drain." New York Times (Jan 4, 2009). pg. BU.4.
- Markowitz, Harry. "Crisis Mode: Modern Portfolio Theory Under Pressure." The Investment Professional (Spring 2009).
- MarksJarvis, Gail. "Diversification Not Always Insulation." Chicago Tribune (Feb 1, 2009).
- McGee, Suzanne. "The Perfect Alternative; In A Bear Market, Finding Assets With A Reliably Negative Correlation To Stocks And Bonds Is All The More Crucial-And All The More Difficult." Financial Planning (Dec. 2008) pg. 60.
- "PIMCO Sells Black Swan Protection." Pensions & Investments (July 20, 2010).
- Scism, Leslie, and Daisy Maxey. "No Place to Hide; Investors Have Seen Even 'Safe' Stock and Bond Funds get Hammered; No Wonder They're So Spooked." Wall Street Journal (Nov 3, 2008) pg. R.1.
- Shinkle, Kirk. "Why Plain-Vanilla Portfolios Fall Short; Today, Diversification Means More than Just Mixing Stocks, Bonds, and Cash." U.S. News & World Report (Jul 1, 2009) pg. 70.
- Szado, Edward. "VIX Futures and Options: A Case Study of Portfolio Diversification During the 2008 Financial Crisis." The Journal of Alternative Investments (Fall 2009) pp. 68 - 85.
- Whaley, Robert E. "Understanding VIX." (2008).