A recently released University of Massachusetts study found that certain investments in futures and options on the CBOE Volatility Index (VIX) could have reduced downside risk for a typical institutional investment portfolio during the 2008 financial crisis.
VIX Futures and Options A Case Study of Portfolio Diversification During the 2008 Financial Crisis by Edward Szado, CFA, Center for International Securities and Derivatives Markets (CISDM) at the University of Massachusetts, Amherst, analyzes data from March 2006 to December 2008 (beginning shortly after the introduction of CBOE VIX options in February of 2006).
The paper first examines investment performance for different investment portfolios during the second half of 2008, when the increased correlations among diverse asset classes generated significant losses for many investors who previously considered themselves well diversified.
The study then explores the impact of adding various exposures of long CBOE VIX futures or long CBOE VIX call options to those portfolios.
For a traditional portfolio of stocks, bonds and alternatives during the five-month time period from August through December 2008, the following are three ways in which long volatility exposure was added and the results during the period studied:
Using a 10% allocation to long near-term CBOE VIX futures —
– Total returns were improved by 15.7 percentage points (improvement to -4.0% from -19.7%)
– Standard deviation was reduced by about one-third (to 16.3% from 25.3%)
Using a 3% allocation to long at-the-money one-month CBOE VIX calls, total returns were increased to +20.8% from -19.7%
Using a 3% allocation to long 25%-out-the-money one-month CBOE VIX calls, period returns increased to +97.2% from -19.7%
The paper concludes by noting that investable VIX products could have been used to provide some much- needed diversification during the 2008 financial crisis. A link to VIX Futures and Options A Case Study of Portfolio Diversification During the 2008 Financial Crisis is available at http://www.cboe.com/VIX.
D.C.