EC Strategies For Trading Inverse Volatility

In this article, I present five different strategies you can use to trade inverse volatility. Why trade inverse volatility you ask?

Because since 2011, trading inverse volatility was probably the most rewarding investment an investor could make in the markets. Annual returns of between 40% - 100% have been possible which crushes any other strategy I know.

In modern markets, the best way to protect capital would be to rotate out of falling assets, like we do in our rotation strategies. This is relatively easy, if you are invested only in a few ETFs, but it is much more difficult if you are invested in a lot of different shares. In such a situation an easy way to protect capital is to hedge it, going long VIX Futures, VIX call options or VIX ETF VXX.

If you trade inverse volatility, which means going short VIX, you play the role of an insurer who sells worried investors an insurance policy to protect them from falling stock markets. To hedge a portfolio by 100% an investor needs to buy VXX ETFs for about 20% of the portfolio value. The VXX ETF loses up to 10% of its value per month, because of the VIX Futures contango, so this means that scared investors are willing to pay 1.5-2% of the portfolio value per month or around 25% per year for this insurance. Investing in inverse volatility means nothing more than taking over the risk and collecting this insurance premium from worried investors and you can capitalize on this with a few simple strategies, which I will show you below.

Something seems afoot. Why do investors pay 25% per year to hedge 100% of an S&P 500 portfolio which traditionally has only achieved a return on average of around 8% in the last 10 years? I am sure many investors must have lost more money paying for this insurance than they would have lost from falling stock markets. But I guess they are paying for their own peace of mind.

Traditionally, it has always been better to hedge a portfolio with US Treasury bonds. These normally have, like VIX products, a negative correlation of about -0.5 to -0.75 with the US stock market, but unlike VIX volatility products, they can achieve long term positive returns.

However, since June 2013, US Treasuries have lost their negative correlation to the stock market, and at the moment there is no other choice to hedge a portfolio than to buy these very expensive VIX products or inverse index ETFs.

This is good news for people like me, who like to trade inverse volatility. However, there is something you need to know. You should never ever trade inverse volatility without being 100% clear on your exit strategy!

Here, I want to present some strategies which may be new to you and will allow you to participate in these high return volatility markets.

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