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It seems that VIX futures could be a great hedge for a long-only stock portfolio since they rise when stocks fall. But how many VIX futures should I buy to hedge my portfolio, and which futures expiration should I use?

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Perhaps a better way would be to buy put options, given that these also rise in premium if the volatility of the underlying increases. Besides that, they naturally increase when the underlying drops. –  user149 Feb 1 '11 at 13:37
@jura25 Thanks for the reminder. I'm looking for alternatives to hedging via option purchases; paying those premia ticks me off. Hedging via option sales is a lot of work. I thought the VIX futures might present an efficient alternative. –  pteetor Feb 2 '11 at 23:07
Reminder to self: In the future I should better look at someone's profile (and, if supplied, their website). ;) I did that now pteetor, and realize that my earlier comment was somewhat out of place given your question and experience. Sorry for that! –  user149 Feb 3 '11 at 7:10
@Jura25 No worries. It's no crime to remind me there is a simple solution to my problem! Thanks. –  pteetor Feb 3 '11 at 15:08
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3 Answers 3

up vote 15 down vote accepted

VIX measures volatility. It doesn't always go up if stocks go down.

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Some have noticed an inverse relationship between returns and volatility -- the so-called "leverage effect." The following discusses it, though there is probably a better resource floating around: ideas.repec.org/p/sfi/sfiwpa/0101120.html –  Todd Schiller Jan 31 '11 at 22:21
@barrycarter: Thanks, good point. I should have said they "often rise when stocks fall." I'm not looking for a perfect hedge, just a reasonable one. –  pteetor Feb 2 '11 at 22:44
@barrycarter @jura25 I think the situation with VIX and stock indexes is more nuanced than people realize. For example, the VIX futures and IWM (the Russell 2000 ETF) are cointegrated according to my R code (ADF p-value < 0.01, using 2 most-recent years of closing prices, hedge ratio 1:1800). If that's true, then the VIX could be an effective hedge for the R2K. My problem is that my portfolio is not perfectly correlated with the R2K, and its size changes over time. It seems the hedge is ripe with possibilities, but I'm not sure how to make the hedge work. –  pteetor Feb 2 '11 at 22:54
OK, I should've said "doesn't necessarily go up". In other words, that's not what VIX is supposed to measure. However, if the market crashes harder than it rebounds (which seems to be the case), the volatility will incidentally increase more when the market goes down. Now... can we go from correlation to prediction? :) –  barrycarter Feb 2 '11 at 23:16
@barrycarter Thanks for your comment. I'm accepting this as the answer because this dialog woke me up: there is no quick answer to my question. I'll need to dig in, explore the relationship between my portfolio and the VIX futures, build a model, and construct the hedge. Time to roll up my sleeves. –  pteetor Feb 3 '11 at 15:17
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VIX also has a lot of complexities that make it a less-than-ideal hedging tool if you're buying a VIX ETF.

http://vixandmore.blogspot.com/ goes into it at length and can probably also answer any questions you have about the VIX as a hedge.

To expand on what @barrycarter said, the VIX is better as a hedge against kurtosis, not against downward movements.

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@Lao-Tzu Thanks. That's a useful observation regarding kurtosis. As for VIX ETFs, I am (very) unlikely to hedge using them: too flaky since I can't control the roll-forward process. I'm likely to stick with the VIX futures... although I'm tempted to experiment also with the synthetic spot (long straddle, adjusted to be delta-neutral through SP500 purchase/sale). –  pteetor Feb 2 '11 at 23:01
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We just made a video on CBOE-VIX Hope you like it https://vimeo.com/41915075

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This is a nice video. It might help if you summarize its explanation of VIX with reference to the question of hedging stocks. –  chrisaycock May 19 '12 at 15:34
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