exposure to the vix

8/14/2019 Exposure to the VIX

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Exposure to the VIX: Is itConditionally Correlated to

S&P 500 Returns?

Andrew Jarmon

Student Investment Fund

Spring 2010


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What is the VIX?

VIX is the ticker symbol for theChicago Board Options ExchangeVolatility Index.

The VIX takes as inputs the currentmarket prices for all out-of-the-money calls and puts for the front

month and second monthexpirations of S&P 500 options

The goal is to estimate the implied

volatility of the S&P 500 index over


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Why is the VIX Helpful?

From option premiums, it can bedetermined what the expectedmarket volatility will be. Typically,

volatility works as a stressindicator.

Volatility is usually the harbinger of

losses, so TV pundits and marketanalysts look to it to get an ideaabout how confident investors are

in the market


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What VIX Exposure MightAchieve

With the credit crisis, many fundmanagers were stumped whenhistorically negatively correlated or

uncollelated assets all becamepositively correlated.

If the VIX were to be uncorrelated

with the market during normalperiods or bull markets, butnegatively correlated during panics,

it would be a fantastic passive


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A Historical Look at the VIX andS&P 500

The methodology for calculating theVIX changed in 2004, and data isonly available from 1990 as far as I

could find

I regressed daily S&P 500 returns ondaily percent changes in the VIX to

try and determine if the conditionalcorrelation I was hoping for was infact true


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Results&Between VIX and S P 500

ot Com Boom-Adjusted R squared . %1 03

Correlation - .0 11

ot Com Bust-Adjusted R squared . %1 89

Correlation .0 14

eal Estate Boom-Adjusted R squared . %21 04

Correlation - .0 46

reditCrisis -Adjusted R squared . %72 69Correlation - .0 85

ecovery ?-Adjusted R squared . %64 68

Correlation - .0 80

( / / / / )1 30 1995 3 28 2000

( / / / / )3 29 2000 7 25 2002

( / / / / )7 24 2002 10 9 2007

( / / / / )7 22 2008 3 9 2009

( / / / / )3 10 2009 2 11 2010


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Options for GettingExposure

Ipath S&P 500 Short-Term FuturesETN (VXX) Average Volume: 3,900,310

Expense Ratio: 0.89% Based on futures in the VIX for the

next 30 days

Ipath S&P 500 Mid Term Futures ETN(VXZ) Average Volume: 90,952

Expense Ratio: 0.89%

Based on futures on the VIX for


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How VIX Futures Work

Since the VIX is not a tangible assetthat one can trade, the futures arecash settled arrangements based

on the opening VIX value for theday the contracts are settled.

VIX futures are quoted in 0.01 of a

point, with each futures tick worth$10. The contract multiplier is$1000.

hi h f h


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Which of the ETNs MostAccurately Mirror the VIX

index?


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Difficulty Getting AppropriateExposure to the VIX


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Suggestion

Go long the mid-term ETN (VXZ) for a

TBD amount


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Conclusion

Pros VXZ seems to have a better payoff, with less

downside and greater upside

This would be taking advantage of the humantendency to extrapolate in to the future badsituations but also to be skeptical about the future

during good times VXZ does not roll as often, and while VXX is more

highly correlated with the actual VIX, VXZ mayoffer a better risk-reward payoff in terms ofinsuring against black swan events

Cons Historical events may not repeat themselves, and we

may see the VIX correlations and adjusted Rsquares of the housing boom during the next bullmarket, and not that of the dot-com run up

This play is going to only pay off during panics, sowhile it might be a la mode right now, there will

be pressure to sell if things continue to get better.If we were to invest in this it would be making a

exposure to the vix

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