Volatility as an Asset Class: The Potential of VIX as a Hedging Tool and the Shortcomings of VIX Exchange - Traded Notes

Abstract

The Chicago Board Options Exchange (CBOE) Market Volatility Index, or VIX, was conceived in 1993 by Professor Robert E. Whaley of Duke University to provide a benchmark of expected short-term volatility. According to the CBOE: “VIX measures 30-day expected volatility of the S&P 500 Index. The components of VIX are near - and next - term put and call options, usually in the first and second S&P 500 Index (SPX) contract months.”

As will be demonstrated in this paper, the value of volatility itself lies in the fact that it is negatively correlated to the returns of the equity market and becomes increasingly so as market declines accelerate. As a result, long exposure to volatility could provide increasing levels of portfolio protection exactly when investors are most in need of such protection. Another way to think about this is that because most investors are net long equities, they are implicitly short volatility, and therefore hedging that exposure may be prudent.

Keywords: VIX, volatility, hedging

JEL Classification: G00, G10, G11