Cheap VIX as a hedging opportunity

by Jay Pestrichelli on December 14th, 2011

If you’ve been waiting to hedge, yesterday might have been the right time. We all know that Rule #1 from the book, Buy and Hedge, is Hedge Every Investment. So if you’re really a Buy and Hedge investor, it means you’re already hedged. However, perhaps you’ve been thinking about a time to roll forward or harvesting some gains and moving limits. If so, yesterday posed an interesting opportunity.

Why was Tuesday the day to do it, you ask? The answer is that volatility was cheap. You might have seen the VIX close lower despite an almost 1% drop in the market. That is an unusual circumstance, and one we like to take advantage of. Believe it or not, the VIX fell and closed below its 200 day moving average yesterday. That means that options were cheaper yesterday than they’ve been on average over the last 200 days.

When was the last time they were below the 200 day? It was July 22nd. That’s right, before the August roller coaster. That seems like an eternity go and its almost hard to believe there was even a market that didn’t have nauseating volatility in it.

We track the daily cost of hedging on via portfolio puts the Resources Page and you can use that as a guide for determining expensive or cheap hedges. See the Protection Connection blog from 12/6.

While we are not proponents of timing the market, taking advantage of cheap volatility value is something we encourage. The good news is that timing when to hedge based on volatility prices has very little consequences if you’re wrong. If it goes even lower after you’ve hedged, it probably means that your underlying investment is having a good day. Also, if you’re using spreads or collars, it just means that the options you sold for credit just paid you even faster. So net-net it’s not a bad thing.

We totally understand that hedging seems like a tough expense to swallow when things look good. When the market volatility is declining we tend to have a positive outlook and worry if we’re wasting money on the hedges. But what the VIX really tells us is how things have been, not where they are going. More to come on that. Just remember Rule #1: Hedge Every Investment. If you do that, you’ll stay ahead of this market.

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