Article by: Jared DeLisle, James S. Doran, Kevin Krieger
Published by: Department of Finance, Florida State University
Date: 3 Mar 2010
“The ability to hedge market downturns without sacrificing upside returns has long been sought by all investors. We consider alternative methods of hedging the S&P 500 with assets that mimic the VIX index in hopes of taking advantage of the asymmetric relationship between volatility and returns. We first demonstrate that if the VIX was investable, and using the fact that volatility mean-reverts, can results in significantly improved portfolio performance over the buy-and-hold index portfolio. However, using VIX futures in a similar fashion does not provide the same results. As such, we deconstruct the VIX Index to find the relevant S&P 500 options that drive the VIX movements. In doing so, we then form a synthetic VIX portfolio using the S&P 500 options and capture returns similar to the VIX index. Our synthetic portfolio is highly liquid and investable, and when combined with a long position in the S&P 500, generates significantly higher returns with lower risk than the buy-and-hold S&P 500 index portfolio.”
Full article (PDF): Link