Saturday, July 27, 2013

Shorting XIV as a hedging strategy

When searching for an opportunity to hedge long investment portfolio against market downside, investors usually buy index puts or buy VIX calls or buy VXX. All of those are proven to be quite expensive, and probably even too expensive to be used in a long run without some kind of an active management strategy.

Fortunately, there is one more option for a hedge that works better - short XIV. XIV is an inverse ETN for volatility index VIX. It suppose to drop when volatility rise and rise when market is calm. It does, but there is a feature of a index-tracking technology that makes XIV to fall faster and to recover slower. So if you short XIV, this all goes to your advantage. As a result, shorting XIV as a hedging strategy looks much better than holding VXX, take a look at the picture:

Black line - short XIV, red line - long VXX, returns in logarithimc scale
As you can see, since 2011 XIV shorting strategy would cost you just a little, which cannot be said about holding VXX, who suffered 99% drop since its inception.

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