Since the 2008 financial crisis, I’ve been contacted regularly by clients and readers who are looking for effective and cost-efficient methods for hedging their portfolios. The more time I’ve spent researching the topic, the more I’ve become convinced that most widely-known methods are ineffective as hedges, inefficient from a cost standpoint, or both. After nearly a year of research, I have developed an alternative method that can provide meaningful protection against sudden and/or large market declines while not imposing excessive costs under ordinary market conditions.
The VIX Portfolio Hedging (VXH) Strategy is designed to offer protection to equity investors against large price declines and market volatility by investing in products linked to the CBOE Volatility Index (VIX). The idea of hedging portfolios using long volatility positions is not new; what is new about this strategy is that it allocates hedging capital by gradually varying the level of exposure as the prevailing market and volatility environments change. Simply put, the strategy dials back hedging exposure when it isn’t needed (without ever becoming entirely inactive), and increases the size of volatility positions when things become more tumultuous.
In the coming days and weeks, I plan to lay out my case for the VXH strategy in the following series of posts:
- Conventional Hedging Methods Are Too Expensive – including both the offerings from banks and other big players and the methods favored by active individual investors.
- Novel Hedging Methods and the Crash Next Time – hedging strategies that require someone to be correct about some particular macroeconomic thesis strike me as silly or scary.
- A Cheaper Way: VXH in a Crisis-Free World – gaining long volatility exposure is easy, but keeping costs down is hard. How would VXH have fared if 2008 had never happened?
- The Discreet Charm of the iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX) – I’m on record as being violently opposed to anyone buying and holding (NYSE:VXX), so why did I build a strategy around it?
- VXH Performance in Detail – all the stats, tables, and equity curves you’re probably wishing I had posted instead of this promissory list.
My goals are to highlight the advantages of this strategy over its peers and to explain every novel or confusing aspect of it, so I’ll thank in advance anyone who submits questions or demands for clarification. For some of my previous discussion of tail risk hedging, see: 1, 2, 3.
Condor Options is a New York-based research and trading firm focusing on market neutral trading strategies. Condor Options publishes an educational newsletter teaching iron condors and volatility-based options trading, with a focus on risk management and quantitative analysis.
Jared Woodardis the principal of Condor Options. With over a decade of experience trading options, equities, and futures, he publishes the Condor Options newsletter (iron condors) and associated blog. Jared has been quoted in various media outlets including The Wall Street Journal, Bloomberg, Financial Times Alphaville, and The Chicago Sun-Times. In 2008 he was profiled as a top options mentor in Stocks, Futures, and Options magazine, and in 2010 was interviewed for Technical Analysis of Stocks & Commodities magazine. He is a founder and contributing editor of Expiring Monthly: The Option Trader’s Journal. He is also an associate member of the National Futures Association and registered principal of Clinamen Financial Group LLC, a commodity trading advisor.