Investment decisions must take into account a perennial and unpredictable constant: stock market volatility. Some years, as in 2011, the fluctuation of stocks is more pronounced. At other times, volatility is almost like a sleeping giant and hardly noticeable.
Day-to-day portfolio management is not just a process of growing capital or producing adequate income, but also controlling volatility to make sure it doesn’t exceed clients’ expectations. For financial advisors, this particular chore means coming up with ways to keep a lid on both risk and volatility.
There are various approaches to volatility management and ETPs offer innovative ways at helping advisors to achieve optimal results.
The VIX — short for Volatility Index — is one of the best known barometers of stock market fear. The VIX is a measure of expected future volatility calculated by the Chicago Board Options Exchange (CBOE). It is quoted in percentage points and roughly translates to the expected movement in the S&P 500 over the next 30 days, which is annualized.
ETPs like the iPath Inverse S&P 500 VIX Short-Term Futures ETN (II) (IVOP) and the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) allow traders to customize the duration of their exposure to volatility.
Other VIX-based ETPs like the VelocityShares Inverse VIX Short-Term ETN (XIV) offer inverse or opposite exposure to stock market volatility, while products like the VelocityShares 2x Short-Term ETN (TVIX) aim for 200 percent daily leveraged exposure.
It’s important for advisors to understand that VIX ETPs do not perfectly track the spot prices for the CBOE Volatility Index because they use futures, which could be in contango. Finally, VIX-based products are offered in either ETF or ETN wrappings from Barclays iPath, Citigroup C-Tracks, Credit Suisse, ProShares, UBS E-TRACS and VelocityShares.
While many investors reject the notion of investing or trading off of volatility, some advisors welcome it as an opportunity, so long as they can control it.
Screening stocks with lower volatility or beta is one strategy for managing market volatility. The idea is to be invested in the market, but with stocks that have less wild movements compared to the rest of the market.