Hedging with VIX Derivatives
The VIX futures and index option markets have experienced tremendous volume growth over the past few years. This has come as a result of institutions accepting volatility as an asset class. Both of these instruments are used as hedges against a drop in stock prices. This use of VIX derivatives comes into play due to the inverse relationship between market implied volatility and the direction of stocks. The performance of these trading vehicles during the bear market of late 2008 and early 2009 solidified their place as a legitimate method of portfolio diversification and hedging.
Although volatility-related trading vehicles continue to be introduced, the two most commonly used hedging vehicles are VIX index options and futures. The main focus of this chapter is how VIX index options and futures are used to hedge equity portfolios. In addition, this chapter covers how these products can be used in place of S&P 500 index options. Also, there is a study of how a consistent mix of VIX futures and long stock would have performed over the past few years. The end of this chapter touches on an academic study that looks at the use of VIX options and futures during a period of market weakness.
HEDGING WITH VIX OPTIONS
The first two tables in this chapter depict open interest for S&P 500 index options and VIX index options. The S&P 500 option open interest is heavily weighted toward at the money contracts, while the VIX index options have the greatest ...