Schaeffer's Trading Floor Blog

The Potential Perils of Low-Volatility Trading

The short- and long-term stories of low-volatility trading

by 4/9/2014 7:28 AM
Stocks quoted in this article:

One of the byproducts of the recent Flight From Momentum is the relative outperformance of lower-octane names. There's an ETF or ETN that tracks everything nowadays, including an iShares S&P 500 Low Volatility Portfolio ETF (SPLV).

The index consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months.

And it's had a veritable boon lately, at least versus the SPDR S&P 500 ETF Trust (SPY) as a whole.

SPLV versus SPY since January 2014
Chart courtesy of TD Ameritrade

2014 highs on Monday! Slow and steady wins the race, right?

Well, time will tell, but using Jan. 1 as a cutoff is a convenient endpoint in this case. As you probably guessed watching the Tesla Motors Inc (NASDAQ:TSLA) names of the world explode over the past year, low volatility has really not been the best place. Here's how SPLV looks compared to SPY over the last 52 weeks.

SPLV versus SPY since April 2013
Chart courtesy of TD Ameritrade

And that's quite a different picture. It probably felt like this in June. Back then, we were terrified that the Fed might taper someday, now we're terrified of I'm honestly not sure what. The catalyst really makes zero difference, as markets get grumpy for whatever reason, and run their course. Or not.

One thing's for sure though -- a flight to "quality" like we're ostensibly seeing now might beget stability, but it's unlikely to lead to a big surge higher. I mean, by definition, these are stocks that move at a relative snail's pace. If they pick up steam, they won't stay in this low-volatility index anyway.

Which actually pops a thought into my head. How is this ETF ever a buy? You'd only want it if you think the market's either going to tread water or decline, right? But if your opinion is that it treads water or declines, why bother owning stocks at all? If you're on the fence, an ETN like the Barclays S&P 500 Dynamic Veqtor ETN (VQT) makes more sense anyway. It essentially owns SPY, but switches over to owning volatility if certain criteria are met.

But I really digress. My real point is there's more evidence out there of an allocation shift out of high-beta issues into safer names. But it's a shift that almost has to prove pretty temporary. All low-volatility bets can really do here is lose less on a dip. If you want to stay exposed to stocks, but want protection, I like the VQT, or simply hedging with some basic index puts.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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