No. of Recommendations: 6
Hello,
Most of the time, a case can be made for stocks in general going lower and for Berkshire going lower. Certainly today, it’s easy to fire off a list of bearish concerns for both the US equity market and Berkshire. On top of general bearishness, there are always rare events, that can cause chaos in financial markets.
Yes that rarely happens and allowing that kind of anxiety to determine your investment positions has not worked historically.
I listened to a podcast recently discussing the VIX. I am quite certain, many of you will be more tuned into how the VIX is used to hedge against big nasty events, (or tail risk to use the lingo) than I am.
I was wondering if any of you have ever looked into buying “tail risk insurance” and what your thoughts were?
My understanding from initial research is along the following lines.
The VIX itself, is a number that attempts to track volatility. Retail investors can buy ETF’s that attempt track the VIX.
The VIX is currently around 14. It doesn’t often get below 10. Since the last spike in volatility, when COVID shook up the world, it has moved in a range between 10 and 30. Currently at 14, it reflects the Goldilocks economy and stock market: soft landing, AI, Fed there if needed, never bet against America, high profit margins etc.
The idea of being long VIX, is so that you can own equities but have this insurance to help you in the event of something like COVID, or the great financial crisis. When those two events happen the VIX jumped 5X in rapid timeframes.
I can see the attraction. If I have $100 million in the S&P 500, or Berkshire (I wish) and something really bad happens: like China invading Taiwan, causing an almost immediate 50% drawdown. I loose $50 million and tell my wife, it will be all good in the long term! However, if I also own $10 million in a VIX futures ETF, along side my $100 million in the S&P 500 or Berkshire, it will probably spike 5X (depending on how wild the event is). I can then sell my VIX futures ETF for $50 million and reinvest in S&P 500, or Berkshire, or just stay in cash. A happy result, compared to the alternative. (Of course, the event itself, could have much wider ramifications for me than avoiding a massive stock market loss.)
On the face of it, that sounds like insurance I should have. However, I don’t believe it is that easy. What is more likely to happen, is that time will pass and the premiums the ETF is burning (renewing its VIX futures contracts) will grind away my $10 million to almost nothing. If an event happens, I will be getting my 5X, but not on my initial $10 million but instead on whatever little is left in my holding at that time, after premiums have eaten my capital.
Therefore, as each year passes without calamity, I would need to buy more and more of this shrinking asset. Psychologically, it would be torture and I might even throw in the towel, just before the big one hits.
Therefore, the only way this would be a good idea, would be if I knew when something was about to happen. That’s quite unlikely to impossible.
Does that sound about right? Appreciate any thoughts…
No. of Recommendations: 1
As you point out, the supposed VIX tracking funds, e.g. VXX, use futures.
But in addition to the roll issue with futures that you mentioned, there are problems specific to VIX futures funds.
Futures on soybeans, coffee, the S&P, pork bellies, etc for which it's at least in principle possible to directly buy the underlying, have a simple "no arbitrage" argument that determines "fair value" for these futures contract. To the extent that arbitrageurs work efficiently, this means that there is a known fair value for these kinds of futures contracts, which constrains nuttiness in these futures prices.
But you can't directly buy the VIX underlying. So, the no-arbitrage fair value argument doesn't work for VIX futures.
A plot of VXX along side VIX shows that despite the tickers differing by just one letter, VXX ain't the VIX.
