Credit: Shutterstock photoSome of the strongest demand for VIX exposure comes from traders and portfolio managers looking for diversifying instruments that are uncorrelated to their present portfolios. Given that the VIX Index is ultimately an S&P 500 - based metric, much analysis tends to focus on the performance of VIX vs the broad US equity market. However, in looking at the market more granularly, we felt it might be helpful to consider how VIX performance has compared with the performance of 25 of the most highly traded US stocks.
Before drilling down into the relative performance of the VIX with respect to individual stocks, it is useful to remind ourselves how the VIX has performed with respect to the major US indexes: the S&P 500 ( SPX ), the Dow Jones Industrial Average ( INDU ), and the Nasdaq Composite ( CCMP ). Below is a chart of the one-month trailing Beta of the VIX (VIX Beta) to those three indexes for two years through October 14, 2016.
A few observations can be made immediately. First, the Beta of the VIX to these three major indices through time appears to be quite similar, with the VIX demonstrating the largest negative Beta to the Dow and the S&P, and only a slightly smaller negative Beta to the Nasdaq. Second, the one-month trailing Beta of the VIX to all three indexes appears to have varied between -3 and -19, and this Beta appears to increase (become more negative) during periods of market distress - October 2014, June 2015, August 2015, January 2016, June 2016, and most recently September 2016.
Taken together these observations are important. Indeed, portfolio managers are likely to be interested in the VIX because of its strongly negative Beta, particularly since the magnitude of that negative beta appears to increase during sharp market downturns.
So let's now turn to popular US stocks. Performing the same sort of analysis on the 25 US stocks with the the largest number of shares traded on October 14th, and a market cap of over $5bn, returns some interesting results [1]. Below is a chart of the one-month trailing beta of the VIX to those 25 stocks over the past two years.
Looking through the crowded chart, a couple of things become clear. First, for most stocks the VIX has demonstrated a very similar Beta relationship with single stocks as it has with the major indexes - significantly increasing negative Beta during market downturns. Second, there seems to be a bimodal distribution in the relationship, with the VIX showing a significantly larger negative Beta to some stocks than to others. This seems particularity pronounced during periods of market distress, but stands out best in the middle of the graph during the first two months of 2016.
Looked at another way, in the table below we present the average one-month trailing Beta of the VIX to the 25 stocks, together with the correlation of these stocks to the S&P 500, and a similar bimodal phenomenon in training Beta can be observed.
Furthermore, the stocks with stronger average negative Betas also tend to experience incredibly strong negative Betas during market downturns. For example, if we look at July last year, the trailing average Beta of the VIX to Pfizer ( PFE ) topped -14, as did JPMorgan ( JPM ) in September this year. So beyond noting how exposure to the VIX has on average offered a stronger negative Beta with stocks like PFE and JPM than it has toAdvanced Micro Devices ( AMD), Freeport-McMoRan ( FCX), andChesapeake Energy ( CHK), it is perhaps important to highlight just how differently these Betas have performed during market downturns. While the VIX's trailing Beta to PFE rose to -14 in July 2015, the VIX Beta of AMD, FCX, and CHK barley exceeded -1. This is an interesting result and could be explained in a couple of ways.
First, stocks with the highest VIX Beta appear to be larger stocks, and thereby make up a larger portion of the S&P 500 - the implied volatility of which is used to derive the value of the VIX Index itself. In fact, stocks that the lowest VIX Beta also appear to have higher correlations to the S&P 500. For example, the three stocks with the highest negative VIX Beta, WFC,General Electric ( GE), andSirius XM ( SIRI) have correlations to the S&P 500 of 0.81, 0.73, 0.68 respectively, while the three stocks with the lowest negative VIX Beta - AMD, FCX, CHK - have correlations to the S&P 500 of just 0.32, 0.47, and 0.34.
This is perhaps the more important observation as it is this facet that could help us understand the relationship between the VIX Index and individual stock holdings. That is to say, stocks whose movements more directly reflect movements in the S&P 500 appear to have the strongest negative Beta relationship with the VIX.
Of course, because the VIX Index itself is not directly investable, the negative Beta relationship to the VIX Index does not directly reflect the performance of any instrument available to hedge these stocks. Instead, any VIX hedge would have to be constructed from futures contracts on the VIX, and it is with that in mind that we recommend reading an earlier article from the REX Shares research team in which we highlighted some ways of gaining VIX exposure and introduced a metric to maximize VIX 'beta per unit daily decay'. Bringing the conclusion made in that piece - that short dated VIX products track the VIX better - with the observations we have made here, it may imply that short dated VIX products offer a viable hedge for US stocks with a high correlation to the S&P 500.
Disclaimer
The use of derivatives, such as futures contracts, swap agreements and options, presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Changes in the value of a derivative may not correlate perfectly with the underlying security, asset, rate or index. Gains or losses in a derivative may be magnified and may be much greater than the derivative's original cost. The derivatives may not always be liquid. The VIX Index is not directly investable. As a result, the behavior of a VIX Futures Contract may be different from traditional futures contracts whose settlement price is based on a specific tradable asset. Several factors may affect the price and/or liquidity of VIX Futures Contracts.
The information contained herein does not constitute an agreement to enter into any business arrangement, or an offering or solicitation for sale of securities. It is not intended that anything stated herein should be construed as an offer or invitation to buy or sell any investment vehicle or for potential investors to engage in any investment activity. All information provided by this investment case is impersonal and not tailored to the needs of any person, entity or group of persons. Nothing contained herein constitutes tax, accounting, regulatory, legal, insurance or investment advice.
These materials have been prepared solely for informational purposes based upon information generally available to the public from sources believed to be reliable. The authors do not guarantee the accuracy, completeness, timeliness or availability of the content and are not responsible for any errors or omissions, regardless of the cause, for the results obtained from the use of the content. The content is provided on an "as is" basis.
The CBOE Volatility Index (the "VIX") is a product of S&P Dow Jones Indices LLC ("SPDJI") and is based on the CBOE VIX methodology, which is the property of Chicago Board Options Exchange ("CBOE"), and has been licensed for use by REX Shares, LLC ("Licensee"). S&P® is a registered trademark of Standard & Poor's Financial Services LLC ("S&P"); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"); CBOE® and VIX® are registered trademarks of the CBOE. The CBOE VIX methodology and the trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Licensee. Any investment product or strategy based on the VIX is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, or CBOE and none of such parties make any representation regarding the advisability of investing in such products nor do they have any liability for any errors, omissions, or interruptions of the Index.
Footnotes
[1] Please note that because these stocks were selected based solely on trading volume and market capitalization on a single day, they may not be, and in fact are not intended to be, representative of the entire market.
See also Sinclair Broadcast Group (SBGI) Q3 2016 Results - Earnings Call Transcript on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
