High market volatility is a defining feature of 2020. But even during less eventful years, market volatility is inevitable – especially in the short term.
In financial markets, volatility measures exactly how risky a particular asset is over a period of time, so when the price of an asset fluctuates quickly within a short period of time, it is considered highly volatile.
Standard deviation is a way to statistically calculate and measure volatility. Over the past two decades, a wide variety of volatility indices for different asset classes have been developed as well as exchange-traded volatility products.
Today we'll take a closer look at such an index and an (ETN) idea that is ideal for short-term investments:
The VIX Index
The ( CBOE: VIX) became the first implied volatility index when it was introduced in 1993 by the Chicago Board Options Exchange (CBOE). The calculation was later revised in 2003. Also known as the "fear index" or "fear meter", "market participants consider the VIX index the primary benchmark for US stock market volatility.
VIX is based on the (SPX), which is considered the core index for US stocks. The detailed calculation of the VIX index is beyond the scope of this article. But at its core, the VIX number shows the market's expectation of 30-day forward-looking volatility implied by the prices of S&P options. Implied volatility is what the market is " implies" that an asset's volatility will be in the future, based on changes in option prices
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Implied volatility is derived from the cost of the option on an asset (such as an index or a stock). It is a dynamic number that reflects market developments. For example, when a company is about to release revenue or makes an important announcement about a product, such as a potential vaccine, traders can review trading patterns for specific options.
As a result, the prices of those options can fluctuate up or down regardless of the actual stock price movement, so if no options were trading on a particular index or stock, there would be no way to reduce implied volatility. to calculate. It's important to remember that implied volatility is based on consensus in the market, but is not necessarily a clear predictor of asset price movement.
VIX is considered a useful tool for investors to value sentiment in the wider US stock markets. In general, the index tends to peak when the index falls sharply, and it usually falls steadily during bull markets.
As fear rose in early March this year, the CBOE Volatility Index exploded to 80 . On March 18, it reached a 52-week high of 85.47. That day also marked 52-week low prices in many US stocks. Currently. VIX floats on 22.
iPath S&P 500 VIX Short-Term Futures ETN
Current Level: $ 25.51
52 Week Range: $ 13.15 – $ 78.84
Investor Fee: 0.89% per annum, or $ 89 on an investment of $ 10,000
The iPath S&P 500 VIX Short-Term Futures ETN (NYSE 🙂 is an exchange-traded note issued by Barclays (NYSE 🙂 .
VXX provides exposure to the that tracks the value of the short-term futures contracts written on the VIX index.
Thus, VXX aims for a daily return that exactly matches the daily change in short-term futures contracts that track the VIX, so that the return of the ETN follows the slope of the futures curve.
The methodology of the index and thus of the ETN generally achieves a high correlation with the spot price of the VIX index. As VXX's recent price action has shown, it tends to rise in value during the trading day if the stock falls. VXX can thus enable bearish investors to hedge their portfolios against a short term market drop.
VXX, however, may not be a suitable long-term addition to a portfolio. Like other exchange-traded volatility products, it is designed with daily returns in mind.
The daily rebalancing has a substantial effect on the reference index (as well as VXX) relative to changes in the VIX index. In fact, the VIX index may perform positively over a period of time, while the underlying index of the ETN and thus the ETN may have a poor performance.
If the ETN is held for more than one session, both positive and negative returns can be aggravated. This warning is usually clearly stated in prospectuses for these exchange-traded products.
Therefore, investors who want to protect their portfolios for an extended period of time should talk to an investment professional about the suitability of volatility products.
Bottom Line
Volatility is a way of calculating the risk of a particular asset over a period of time. At the beginning of the second half of August, market volatility, as measured by the popular VIX index, is low. Potential headlines from vaccines continue to captivate market participants. However, sentiment can change quickly. The looming US presidential election, a shrinking global economy, pandemic developments and other unforeseen geopolitical events could quickly bring volatility back to the market. In the coming weeks, we'll be looking at other volatility ETFs and ETNs.
