Using the VIX to mitigate volatility risk

Written on May 6, 2008 by OptionsRopeaDope

I was just reading over the VIX page on the CBOE site and there are some good resources if you scroll down the page, including this graph:

In short, that shows that having 20% of a stock portfolio in VDX futures will reduce portfolio volatility a good deal, while hardly affecting your return. There are a few reasons -

  • The VIX has a strong negative correlation to the DJIA (about 86%). In lay terms, that means when indexes fall, the VIX rises, and vice versa
  • The VIX is mean reverting… so if you get in the futures around the historical mean (say, 18-22 or so?) it will go up, and down, but be around there many times. So most of that profit (and loss) in the VIX is short term.

I found this pretty cool. By best practice, your portfolio of option trades at any time should have minimal volatility risk, with positive and negative vega trades balancing each other, but I’d still be interested in seeing some strategies where the VIX is used to hegde an Iron Condor, for example. I haven’t seen any.

Here is a pdf of a collar for the VIX.

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    • Category Posted in Vix, Misc

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