Actively Using Passive Sectors to Generate Alpha Using the VIX

2020 NAAIM Founders Award & 2020 Dow Award Finalist

19 Pages Posted: 1 Dec 2020

Date Written: November 30, 2019

Abstract

A significant amount of academic research has documented momentum within and across broad sectors of the stock market as a means of generating alpha over a passive benchmark. However, few studies approach sector allocation from a mean reversion perspective using the Chicago Board of Exchange (CBOE) Volatility Index (VIX) as the trigger. We find that positioning into defensive sectors during periods of low volatility for the stock market, and into cyclical sectors during periods of high volatility produces significant long-term alpha. Using this framework, we back-test a dollar neutral strategy documenting return differentials, and create a modified S&P 500 Index that over-weights and underweights cyclical and defensive sectors systematically based on VIX levels. Absolute and relative returns for a sector allocation strategy that uses VIX levels significantly outperforms a passive buy and hold approach by using mean reversion to generate alpha. We postulate that the approach likely works because of behavioral biases related to loss aversion and the disposition effect creating mispricing that are repeatable and exploitable during periods of extreme market stress.

Keywords: Volatility, VIX, Sectors, Investing, Stock Market

Suggested Citation

Gayed, Michael, Actively Using Passive Sectors to Generate Alpha Using the VIX (November 30, 2019). 2020 NAAIM Founders Award & 2020 Dow Award Finalist, Available at SSRN: https://ssrn.com/abstract=3718824 or http://dx.doi.org/10.2139/ssrn.3718824

Michael Gayed (Contact Author)

Lead-Lag Publishing, LLC ( email )

923 McDonald Avenue
Suite #205
Brooklyn, NY 11223
United States

HOME PAGE: http://www.leadlagreport.com

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