As the dust settles from the crises in Japan and Libya, now may be a good time for risk managers to think about trading off the VIX volatility index.
The Chicago Board Options Exchange’s Market Volatility Index, or VIX, was trading at around 17 on Friday after having traded as high as 31 in March. And that kind of volatility creates opportunities for investors who are paying close attention to the vagaries of the VIX, according to Laurence Wormald (left), the London-based head of research for SunGard Financial Systems, which serves about 200 institutional investment clients.
“The VIX predictably goes up when people are worried, and it tends to subside over time. In my opinion, as a professional risk manager, that’s when I like to buy it, because other people are getting complacent, and I know for sure that sometime soon it’s going to spike again,” Wormald told AdvisorOne on Friday. “We predicted back in December that the VIX could not stay as low as 16," where it stood in December 2010, Womald said. "We weren’t at all surprised to see it go to 30.”
Asked if he was buying into the index now, Wormald answered in the affirmative.
“I would be quite prepared to buy it now,” he said, “because I think our macro model shows a host of risks that haven’t gone away—risks in the bond markets, especially in the euro area;, risks in the emerging markets, especially Chinese property; and risks in the geopolitical market, which will affect our oil and energy costs, which are obviously happening in the Middle East. Three big economic risk factors have not gone away in our model.”
The VIX spiked two weeks ago after the Japanese earthquake and tsunami, followed by the allied military action in Libya, Wormald said. “People were feeling scared and the price of the VIX went up. Now it has dropped because the Japanese tsunami is over, and we know what it’s about now and the nuclear issue is kind of resolved. Whenever there’s a resolution, people understand the risk to have gone down again.”
In short, the VIX predictably goes up when people are worried, and it tends to subside over time, Wormald said.
But Luke Rahbari, managing partner of Stutland Volatility Group, Chicago, was a skeptic, saying that volatility is hard to measure.
“There’s uncertainty in the market, and the VIX on a relative basis might
be a little lower. But just because something is low or it hasn’t moved in a while doesn’t mean it’s due or can’t go lower or stay low for a prolonged period of time,” Rahbari said, pointing to the example of Japan’s Lost Decade, which has now grown to last for 20 years.
“It’s an old saying: The market can stay irrational a lot longer than you can stay liquid,” Rahbari warned.
Here’s what every investor should do, Rahbari said: “They should take a look at all of their holdings. They should look at different scenarios that can happen and then determine what their risk appetite is. If you think you’ve made a lot of money in the run so far, and you really can’t stomach a 5% or 10% loss, then you can go and buy some insurance. Buying the VIX if you have stocks is like buying some insurance on that portfolio and saying, ‘I’m willing to lose 1% or 2%, but I can’t lose a lot more.’”
Read ‘Volatility: Time to Buy, Sell or Embrace It?’ at AdvisorOne.com.