According to the latest Risk and Volatility dashboard released by S&P Dow Jones Indices, US equity volatility, both realized and implied, are at significantly depressed levels. The VIX Index, a measure of implied volatility derived from the pricing of 30-day futures contracts on the S&P 500 Index, is at 11.97, the highest level of volatility in February so far, but well below the long-term average.
Tim Edwards, Senior Director, Index Investment Strategy at S&P Dow Jones Indices.
Tim Edwards, Senior Director, Index Investment Strategy at S&P Dow Jones Indices, commented: “It is now ten weeks and counting since the S&P 500 moved by more than one percent in a single trading day, which is the longest streak since the summer of 2014. It is a remarkable time. Following a week in which both US and global equity indices breached all-time highs, the economic measurements of volatility show very few visible signs of distress in the market.”
US equities are not the only market to be indicating lower uncertainty with every one of S&P’s volatility measures declining since its last report, and only US interest rate volatility recorded above its trailing 200-day average
The largest decline (in percentage terms) was in euro volatility, which has been steadily falling since the New Year. European equity volatility fell in tandem with the VSTOXX Index level of 14.68 being the lowest in more than two years.
Stronger than usual diversification effects have been dampening the swings across all markets: the average realized volatility among S&P 500 stocks remains at moderate levels, but correlation among stocks has been unusually low. Edwards notes however that investors are at risk of complacency in a low VIX environment that would otherwise seem to harbour significant political risks.
For investors looking to protect their portfolios from rising volatility, VIX-linked exchange-traded products, such as the Boost S&P 500 VIX Short-Term Futures 2.25x Leverage Daily ETP (LON: VIXL), could provide an effective hedge.
Similarly, for traders with a shorter time horizon, the current calm could present an opportunity to take out a speculative long position in such products, which would profit from an increase in volatility.
The Boost ETP provides 2.25 times the performance of a daily rolling long position in first and second month VIX futures contracts. This means that if the S&P 500 VIX Short-Term Futures Index, its underlying reference, rises by 1% over a day, then the ETP will rise by 2.25%, excluding fees. With annual fees of 0.99%, the ETP is pricey but nonetheless provides investors with a powerful tool.
An alternative to the Boost ETP is the Lyxor S&P 500 VIX Futures Enhanced Roll (Lux) UCITS ETF (LVO), listed on Euronext, Borsa Italiana and Xetra. This Lyxor ETF track the S&P 500 VIX Futures Enhanced Roll Index, a second-generation volatility index that dynamically switches between a short-term VIX futures and a mid-term VIX futures, based on their relative implied volatility, in order to model a cost-efficient exposure to volatility in the broad equity market. With fees of 0.60% is cheaper than the Boost offering, but lacks the leverage factor, making it more expensive on exposure-adjusted basis.
In the US, the two most popular VIX-related ETPs are the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) and the ProShares VIX Short-Term Futures ETF (NYSE: VIXY). Both offer exposure to a daily rolling long position in short-term VIX futures contracts and have total expense ratios of 0.89% and 0.85%, respectively.
Of course, VIX ETPs are just one way to protect against increases in volatility. Other options include precious metals ETPs, particularly those linked to gold, or low volatility or minimum variance ETFs which typically track stocks with lower volatility characteristics relative to the broader equity market.