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VIX index and portfolio hedging

The volatility index cannot be used as a hedging instrument for a portfolio. But such an opportunity really exists for the instruments that are traded on its basis - futures on the volatility index and VXX, which is traded as an ETF and basically contains two futures closest to expiration.

VXX has a firm inverse correlation with the SP500 index and in this sense, using long positions in volatility can be a reasonable concept for hedging.

But not everything is so simple. What are the main problems with VXX hedging?

The impact of contango - which is relentlessly and mercilessly destroying the value of VXX and, as a consequence, the value of the hedging position decreases, which reduces the potential for hedging.

Over-hedging risk is a common problem in which portfolio volatility decreases and returns decline at a faster rate. Hedging impairs the Sharpe ratio, and as a result, the value of the Sharpe ratio becomes lower with hedging than without it.

From the link below, I posted a backtest with two portfolios with and without VXX hedging:

Backtest Portfolio Asset Allocation

In general, it can be argued that systematic buying to hedge a portfolio does not work with VXX. How to improve the effectiveness of VXX for its use as a hedging instrument? It is obvious that if you buy VXX on the eve of a turbulent zone in the market, it can create a colossal compensating potential and mitigate negative fluctuations in the portfolio. But how to determine the period of instability onset and whether there are appropriate diagnostic methods for impending instability.

VXX Pros use several basic techniques to Increase the effectiveness of VXX buying and predicting the spike of Volatility: 

1. Analysis of the structure of the futures curve and opening a long position in VXX only when backwardation occurs.

2. Analysis of the 100-day moving average and buying VXX in case of price bouncing from the bottom up and crossing the SMA.

The analysis of VXX buying conditions for hedging portfolios is often the subject of a comprehensive study of investors that use quantitative trading methods and statistical analysis. One of these portfolios is the spxhedgefund, which is publicly available on the Etoro platform.
 

The portfolio report is available here
 

Vakhtang Mindiashvili


https://www.bestcopytrade.com/traders-rating/spxhedgefund.html

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