Revisiting my VIX trade

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Two weeks ago I posted an article entitled I have just hedged my equities by going long volatility and remarked: “I am of the opinion that the nascent cyclical bull market is looking tired, on top of the fact that stocks over over-loved, overbought and overvalued.”

I then also suggested that one should consider hedging equity portfolios by “betting on increased volatility that is bound to happen with any stock market correction. One can do this by buying either the iPath S&P 500 VIX Short-term Futures ETN (VXX) or iPath S&P 500 VIX Mid-Term Futures ETN (VXZ). (VXX invests in VIX futures contracts ending within the next two months, whereas VXZ is made up of VIX futures contracts running for four to seven months.)

Since then stock markets peaked with most bourses making highs two weeks ago, and the CBOE Volatility (VIX) Index, also known as Wall Street’s “fear index”, leaped skywards (see chart below). The VIX is a measure of the implied volatility of S&P 500 Index options – a high value corresponds to a more volatile market and therefore more costly options. “The boys and girls are getting nervous (as well they should), and they’re finally buying puts for insurance,” said Richard Russell (Dow Theory Letters).


The chart below shows how the VIX has jumped by 99% since April 23. VXX and VXZ are up by 42% and 21% respectively. As mentioned previously, these products generally represent an excellent way of hedging against stock market declines, but do not always fully track the VIX as a result of investing in futures that are also affected by other risk factors. The ETNs have nevertheless provided more than adequate protection against the stock market’s correction.


The following remarks regarding the VIX come courtesy of David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates:

“Including yesterday’s further up-move (+4.5% to 25), the VIX Index is now up 50% on a 20-day basis. Ouch!

“This is symptomatic of the onset of a bear market phase, or at the least, the very late stage of a bull run. But the key takeaway is that spasms like we just saw are not symbolic of the early or mid-stages of a bull market. The post-bailout/stimulus effects of the last 13 months were fun while they lasted, but the bull now looks to be rolling over, in my humble opinion.

“In the current run, this is the first time we have seen such a big increase in the VIX Index (on a 20-day basis). There was only one other time, back on February 8, 2010 when the VIX Index rose 51% on a 20-day basis. Of course, that was seen as a ‘buy-the-dip’ scenario; however, what it represented was an initial market peak à la July 2007, and today likely represents the subsequent blow-off peak we saw in October 2007. If there are any differences, the market is not quite at the same extreme overvalued level and technical divergences are not as acute. But investor sentiment is almost equally as complacent and denial over double-dip outcomes is as evident as recession expectations were back then when the consensus was for a soft landing (the economic downturn was only two months away – staring us in the face, and yet so many nay sayers).

“Back in the bull market of 2003-2007 when the S&P 500 doubled, the VIX Index never surged to such an extent as it just has — at least not until the rally was all but over (mid-March when the ABX indices were melting) and then in August and November (when the mortgage strains morphed into an outright credit crisis).

“By way of comparison, in the 2000-2003 bear market, the VIX Index was up this much over a 20-day span during the depths of the recession (September 2001) and during the growth relapse and just ahead of the retest and break of the prior market lows in 2002 (the VIX broke out like this in late July and early August of 2002).”

Food for thought from David! I will comment more fully on the market outlook over the next few days. Suffice to say I am of the opinion that the pullback is not over yet and therefore hold mostly cash and gold, together with the VIX-hedged position, to protect the equities in my portfolio.

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