How VIX ETFs Correlate With The S&P 500

Includes: TVIX, VXX, XIV, ZIV
by: Benjamin Goldman

I have heard a lot of talk about how going long on VIX is a good way to hedge a portfolio. VIX is the annualized expected change in the S&P 500 over the next 30 days. It is based on a weighted blend of option prices and there are is a host of ways to take a position in the index, including buying options and futures from the Chicago Board Options Exchange or investing in a host of ETFs including VXX, XIV, TVIX, and ZIV. In this article, I evaluate how well VXX shares hedge against the S&P 500.

As one would expect, the day to day change in VXX has a negative correlation with the day to day change in the S&P 500 index. The correlation has been -0.8978 in the last six months and -0.8804 in the last year. Since the inception of VXX on January 30, 2009, the correlation has been -0.8384. I also calculated the correlation of the day to day change in VXX with the absolute value of the day to day change in the S&P 500 index. These correlations were 0.3004 in the last six months, 0.2915 in the last year, and 0.1690 since the inception of VXX. To have an idea of how much VXX an investor would need to buy to completely hedge his long position, I calculated short term Betas of VXX. The numbers I got were -2.72 in the last six months, -2.87 in the last year, and -2.29 since the inception of VXX.

What all these numbers tell me is that buying VIX ETFs may not be the best way to hedge your portfolio (all VIX ETFs mirror each other pretty well so I think it's safe to generalize). The correlation between VXX and the S&P 500 is not high enough to consider it a good hedge. In addition, VXX itself is very volatile so any major changes in the stock market will force investors to change their positions in VXX and their current holdings on a frequent basis. For the average investor, this can be too expensive.

In addition, there are plenty of better ways to hedge your portfolio than holding a position in VIX. Investors can short the S&P 500 and gain very nice returns if their long holdings outperform the market. To protect against both sides of volatility, investors can buy S&P 500 puts and calls. For investors with very concentrated portfolios, I suggest at least buying put options on shares to have some downside protection.

In conclusion, there are plenty of good ways for investors to hedge their portfolios without investing in VIX. The index itself does not correlate well enough with short term changes in the S&P 500 and there are much better hedging alternatives. When looking at potential hedging strategies, it is important to find options that will have downside protection, be easy to manage, and have predictable outcomes no matter what the situation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.