Thursday, August 20, 2015

Stock vs. Volatility: Possible Reverse

The picture below is a portfolio constructed from 3 ETFs: SPY for stocks and VXX, VXZ for volatility. Each part of the portfolio is volatility-normalized (one-month daily price change st-dev).


Since January, volatility fell despite stocks were locked at the same level. What I see now is a good chance that next couple of month we'll see a reverse dynamics of this stock vs. volatility pair. Either volatility will surge ahead of falling stocks - see November-January as an example - or the market will go up with volatility being pretty high with flat term structure. I know the last option sounds strange, but you'll never know.

In any case, now is a good time to use volatility products for hedging against the stock market downside. Chances are good this time you'll not be punished for doing so by the evil VIX contango.

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