My column this weekend in the Financial Times – online in the next few days – looks at leveraged trackers as a way of hedging the risk of a big market sell off. My hunch is that the probability of a circa 10% correction in US equities is growing by the day and if I had to wave a finger in the air, I’d say it’s at the 25 to 50% probability level before the end of the year. Obviously, I hope I am proved wrong but the longer the current bullish run lasts the more painful the eventual fall.
So, what might one do? As I said, in the FT this weekend I look at short and leveraged trackers otherwise known as S&L ETPs. These have been regarded as exclusively the preserve of day traders, but I think they do have some value for short term trades that last weeks or even a small number of months.
In the table below I explore two alternatives to S&L ETPs. The first are spread betting companies, who make lost of money out of heightened vol and trading.
The second is a useful Vix tracker from Wisdom Tree with the ticker VIXL. It’s a 2.5 times leveraged tracker on the Vix short term contracts.
In both cases I’ve looked at recent sell offs and then looked at
- What happened to these trackers if you’d have had perfect foresight and bought on the days of peak bullishness BEFORE the sell off and then sold at the trough
- As the scenario above is clearly ridiculous, I’ve also looked at what happened if you bought roughly three weeks before the peak bull moment and then sold two to three weeks after the trough.
What the numbers reveal is that although the spreadbetting companies do provide some useful returns, it’s not very pronounced. In the 2018 sell off for instance the spreadbetters did very badly. Also, in the Feb/March 2020 sell off the spreadbetters did eventually come into their own but during the core four weeks of peak bearishness, they faltered.
In my view the pattern isn’t strong enough to justify using the likes of Plus500 or IG as narrow hedges over a short period of time. My guess is that spreadbetters work much better if the period of volatility is much longer and markets move in a sideways trade as the bears and bulls battle it out for market confidence.
The Vix 2.5 times tracker by contrast is much, much more effective – though the milder sell off in September 2020 wasn’t a notable let down, possibly because the sell off was so short in terms of turbulent days.
|Name||Price||TIDM||Price change %||%chg 1y|
|1 mth||1 year|
|IG Group Holdings PLC||825.25p||IGG||0.0303||6.21|
|CMC Markets PLC||255.5p||CMCX||-5.72||-23.4|
|WisdomTree S&P 500 VIX Short-Term Futures 2.25x Daily Leveraged||406.95¢||VIXL||-33.1||-98|
|VIX (Volatility Index) New Methodology||15.01||VIX||-15.4||-45.5|
|Name||Peak bull to bear ; perfect timing|
|%chg 21/2/20 to 23/3/20||%chg 2/9/20 to 23/9/20||%chg 20/9/18 to 24/12/18||%chg 20/7/15 to 11/2/16|
|IG Group Holdings PLC||-18.7||5.51||-26.8||-12.4|
|CMC Markets PLC||-11.9||7.05||-37.7|
|WisdomTree S&P 500 VIX Short-Term Futures 2.25x Daily Leveraged||1220||-20.5||205|
|VIX (Volatility Index) New Methodology||261||7.56||206||130|
|Name||Extended periods: buying early, selling later|
|%chg 1/2/20 to 1/4/20||%chg 1/9/18 to 1/1/19||%chg 1/8/20 to 1/10/20||%chg 1/7/15 to 29/2/16|
|IG Group Holdings PLC||2.44||-36.9||8.7||0.528|
|CMC Markets PLC||27.6||-38.4|
|WisdomTree S&P 500 VIX Short-Term Futures 2.25x Daily Leveraged||627||135||-34.2|
|VIX (Volatility Index) New Methodology||203||97.7||9.16||27.7|
This question of timescales for heightened volatility prompts the chart below which is from the annual Credit Suisse Yearbook, by Paul Marsh, Elroy Dimson and Mike Staunton. The chart shows the number of trading days it took for the S&P 500 (whose vol is captured by Vix) to revert to its Vix mean.
The average was 66 days for the Vix to fully revert to mean but I think from memory the period it took for the half life to emerge was between 15 and 35. Again my own finger in the air exercise would pin a number of 20 as the more recent half life average, which implies four working weeks from peak vol to half that peak level. If we build a few weeks in either side to allow for poor market timing we end up with roughly two months as the maximum holding period for VIXL, the Wisdom Tree 2.5 times leveraged Vix tracker. Obviously there are some important cautions, not least that because of the weight of Vix ETPs in the US, the short term futures markets can behave in strange ways – many observers think that these short term futures are becoming an increasingly blunt tool.