The Portfolio Diversification Potential of Long VIX Futures and Options Strategies

Abstract

It is well established that the VIX Index tends to be negatively correlated with equity markets. This suggests that VIX futures and options may have the potential to provide significant diversification benefits for traditional portfolios. However, since the term structure of VIX futures is generally upward sloping, long VIX futures positions can place a significant drag on portfolio performance. In this paper we consider the performance of strategies that buy VIX futures or VIX call options in a portfolio context in 2008 and 2016, as well as over a 10+ year period from 2006 to 2017. In addition, we consider alternative strategies including long S&P 500® protective put strategies and the dynamic S&P 500 plus VIX call buying strategy of the VXTH index. Meaningful portfolio diversification benefits for risk-averse investors are possible over particular time periods with small allocations to long VIX futures or call options, but there can be substantial portfolio drag if large allocations are made over long time periods during which there are flat to rising stock markets.