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Quant Investing: VIX Indicator and Strategy

VIX instrument is an effective hedge tool only if you can capture timing.

VIX is a mechanically designed index. It is an indicator of gauging market volatility and sentiment shifts. VIX index level increases when market risk intensifies. Financial instruments linked to VIX provide insurance-like downside protection. What is the downside? VIX hedging is very costly when bluntly buying and holding.

We study VIX hedging timing and allocate VIX ETF to the portfolio when necessary. The Table below shows this hedging improves overall investment performance.

Closer examination points two directions. First, we might need different forms of VIX indicators for bull or bear market regime. When the market is calm and overly comfortable, the level of VIX is not as significant as spike frequency. On the contrary, when VIX is peaked at market turmoil, its level (or standard deviation) provides instant feedback, hence a more effective hedge.

Second, we can do VIX hedging through various instruments and dynamic strategies. How to respond (Buy/Sell/Hold) appropriately to a VIX event or a combination of risk signals is critical. Is there an equivalent portfolio de-leveraging mechanism similar to a VIX purchase? We shall find out more in this research.

Petty Chen
AVP Quantitative Finance, Gamma Paradigm

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