Practical Applications of Volatility as an Asset Class: Holding VIX in a Portfolio

Practical Applications Summary

In Volatility as an Asset Class: Holding VIX in a Portfolio from the Fall 2018 issue of The Journal of Alternative Investments, authors Jason Berkowitz (St. John’s University) and R. Jared DeLisle (Utah State University) explore whether investors can diversify their stock portfolios by adding assets linked to the Chicago Board Options Exchange’s Volatility Index (VIX). Diversification is increasingly difficult to achieve because asset classes that have historically moved in opposite directions during times of financial distress now tend to all fall in value during such crises. However, the VIX tends to go up when the S&P 500 Index (SPX) goes down—so theoretically, a small position in the VIX should provide a small hedge in an SPX-based portfolio.

Unfortunately, the VIX itself is not a traded asset that can be purchased like a stock. Because the only VIX-related products currently available for investment are derivatives, the authors studied whether investors can diversify an SPX-based portfolio by investing in VIX futures and call options, as well as SPX put options and straddles. They found that all of these assets are costly and have negative returns—and that all the hypothetical portfolios containing them underperform a 100% SPX portfolio. Therefore, diversifying by investing in the VIX is not possible in the real world.