This article was prepared in connection with the launch of Mini Cboe Volatility Index (Mini VIXTM) futures on Cboe Futures Exchange, LLC (CFE). Before you trade Mini VIX futures, it's important to understand the following:
- Mini VIX futures are complicated financial products that are suitable only for sophisticated market participants.
- Mini VIX futures involve the risk of loss, which can be substantial and can exceed the amount of money deposited for the futures position.
- Market participants should put at risk only funds that they can afford to lose without affecting their lifestyles.
- Before transacting in Mini VIX futures, market participants should fully inform themselves about the characteristics and risks of Mini VIX futures, including in particular those described below. Mini VIX futures market participants also should make sure they understand the product specifications and the methodologies for calculating the underlying VIX® Index and the settlement values for Mini VIX futures.
The foremost concern for most investors tends to be capital protection, even when the additional objective of income generation is present.
The VIX suite of products uniquely affords market participants the opportunity to potentially insulate their capital from the risks associated with large, unexpected market moves. Because VIX futures and options often demonstrate performance that is inversely correlated with the U.S. stock market, this feature may offer a diversification element when added to an investor's portfolio.
Research studies suggest that relatively small allocations to VIX futures or options-based strategies may mute the impact of sharp S&P 500 Index declines. Most recently, Prof. Edward Szado released a study examining the performance of strategies that buy VIX futures or VIX call options as well as alternative strategies, including long S&P 500 Index protective put strategies, as part of a protective portfolio allocation.
VIX futures and options enable market participants to gain exposure to expected market volatility that has been isolated, which is independent of overall market direction. Most passive market participants are "long only" and tend to benefit from markets that move higher over time. Those positions are implicitly "short volatility." As such, VIX futures and/or options may be used to hedge portfolios against volatility shocks when used passively or, when used strategically, may be used to potentially reduce overall portfolio risk.
Recall the negative correlation relationship between the S&P 500 Index and VIX futures. With the understanding that a hedge is something that has a value because it moves in the opposite direction of the asset you're looking to protect, one can see why the VIX product complex is potentially a compelling addition to a diversified portfolio.
Cboe Benchmark Indices
The Cboe Benchmark Indices measure the performance of hypothetical strategies using index options, VIX options or VIX futures.
Cboe VIX Tail Hedge Index (VXTH)
Strategy: VIX call option buying
VXTH illustrates the effect of incorporating a VIX call option buying strategy in a portfolio that is long the U.S. Equity market.
VXTH was higher by roughly 92% in late July, which compares to an S&P 500 Index that measured unchanged on the year.
- Buys one-month 30-delta VIX call options.
- New VIX call options are purchased monthly, a procedure known as the "roll."
- The weight of the VIX call options in the portfolio varies at each roll and depends on the forward value of VIX Index, an indicator for the perceived probability of a "swan event."
For more information, cboe.com/VXTH