Covering Your Downside – Shielding Against Market Downturns

Matt Raebel

Matt Raebel


The year 2020 has been a time of political and economic turbulence, resulting in significant volatility. For investors, it is a good time to look for strategies for mitigating downside risk exposure. An October 12 webinar from Cboe Global Markets offered to teach attendees how VIX products can be used for this purpose. 

The webinar, titled, “Shielding Against Drawdowns Using VIX Tradeable Products,” was moderated by Cboe’s Matt Moran, head of index insights at the Cboe Options Institute. The speakers included Edward Szado, chair of the Department of Finance and associate professor at Providence College, and Joshua Lisser, senior vice president and head of the index strategies team at AllianceBernstein. The webinar was clearly not aimed at rookie options traders – attendees appeared to consist primarily of fund managers and experienced traders, and the language used by Szado, Lisser, and Moran reflected that.

Szado highlighted several of Cboe’s benchmark indices based on the VIX, Cboe’s signature volatility index based on the real-time, mid-quote prices of S&P 500 Index (SPX) call and put options. He said the VIX Premium Strategy Index (VPD), the Cboe Capped VIX Premium Strategy Indexes (VPN), the VIX Strangle Index (VSTG), and several others are useful tools for protecting against downside risk. 

Although buying VIX futures is a popular hedging strategy for portfolio managers, buying VIX futures without a strategy is not enough, Szado said. Long VIX futures and call options provide risk mitigation in times of equity downturn, he said, but they must be used selectively.

For example, Szado pointed out that combining calls on VIX futures with an SPX collar tends to be an effective strategy for portfolio managers hedging during times of economic downturn (a collar is a strategy in which a trader buys a put option and finances it by writing a call option, protecting their position from downside risk but limiting their potential profit). 

He also said effective hedging strategies using VIX products require the application of specific indices based on their functions, which are designed to encapsulate different trading strategies. For example, the Cboe VIX Tail Hedge Index (VXTH) buys 30-delta VIX call options monthly, rolling positions over based on their likelihood of a “black swan” event – a rare market-moving event that typical forecasting tools and practices may fail to anticipate. Because each index embodies a different strategy, different VIX products may be more effective for different kinds of portfolios, Szado said.

Lisser reviewed the performance of the markets over the past year. “Market risk increased dramatically with expectations for continued market risk,” he noted. 

Before investors choose a strategy, he said, they have to think about what they are trying to accomplish. Do they want to take a position for a specific timeframe, or do they want insurance that’s “always on?” Do they want to focus on increasing or decreasing exposure to specific Greeks (metrics used to price options)? What will it cost to take or, as the case may be, hold a position? What is the structure of the underlying?

Lisser also provided tips for ensuring the effectiveness of an options strategy. He discussed gamma hedging – the process of making an options position “gamma neutral” by supplementing a position with other options, ensuring no or little change in the delta, even if the underlying security experiences volatility in either direction.

He said that since longer puts have more exposure to vega (a measure of changes in volatility of an underlying asset’s value), it’s more likely the cost of the underlying asset will change. When holding positions where this is the case, Lisser recommended funding the options by selling shorter-dated options; if you’re going to roll your position, you’re going to need a way to pay for it. 

Even when things seem bleak, it’s always worth considering that you have more – pardon the pun – options than you may think for making it through difficult periods. When it comes to protecting against downside risk these days – as Szado and Lisser demonstrated – investors have an abundance of tools at their disposal, even if some of them require extra guidance to wield effectively.

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