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So I got this question from a Twitter friend the other day.
hey, what is the best/cheapest way the get some vix ... looking to get some "drop" protection
I had to answer in under 140 characters because … well, I actually I didn't, I could have just done something radical and sent an email.
The gist was that I would rather just buy index puts. As I'm sure I've written too often, all CBOE Volatility Index (VIX) products have built-in challenges. With the VIX term structure sloped upwards, you can only buy VIX anywhere near here if you stay very nearby in time. And if you stay too close in time, you are really only betting on a very near-term VIX pop.
My sense is that my friend -- and most everyone else with this thought -- want to lock in today's low volatility as a hedge against a drop over a longer time frame. And that's a problem in VIX-land so long as the futures curve maintains its current shape. And with VIX anywhere under the mid-teens, it will almost definitely maintain its current shape. Ergo, it's literally impossible to lock in VIX here.
But hey, you can buy options at an implied volatility around where you see the VIX on the board, hence my thought that simply buying puts makes some sense. Of course that hasn't worked too well either lately. You have gotten a double whammy there. With the market very near highs, it's highly likely that the underlying stock or index is higher now than when you hypothetically bought puts. What's more, implied volatility has probably declined since you bought them, unless you bought them over the last week and caught a modest VIX uptick. And I'll even throw in that with realized volatility under 5 (in the S&P 500 Index [SPX]), you haven't gotten any trading value from any puts either.
If you look at any of this as the cost of portfolio insurance, then it's probably a small price to pay against presumed gains everywhere else. With VIX products, you lose money by paying for a volatility uptick that hasn't even happened yet. In basic options, you lose money paying time premiums. The net cost is more or less the same.
Why are straight options better?
Well, I'm not sure they are actually better. It's just personal preference. A put is a direct bet, with a fixed cost and a specific time frame. The lower the implied volatility, the lower the cost of the bet. A VIX product takes the bet one level further. It's more or less a wager against the market, but the degree to which VIX inverse correlates with the market can fluctuate. Further, time decay on an option is relatively easy to calculate (or have your trading platform calculate for you) whereas the path of a VIX hedge is much more variable.
Anyway, that's just my opinion, everyone's mileage may vary on this topic.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.