VIX: A Hedge To Consider For Your Portfolio

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Includes: CVOL, IVOP, SVXY, TVIX, TVIZ, UVXY, VIIX, VIIZ, VIXM, VIXY, VXDN, VXUP, VXX, VXZ, XIV, XVIX, XVZ, XXV, ZIV
by: Chris Kobryn

Summary

Current market conditions feel like the calm before the storm.

Investing in an ETF that tracks the VIX index could be very profitable.

Protect your portfolio against another potential crash.

It is not uncommon to see the markets follow irrational trends. Sometimes, the markets will climb up or drop down on information that may indicate contrary trends. This past month I've been watching the markets with immense caution; I was a little surprised that we have seen US stocks rise for a fifth straight week. For the long run, I have a handful of stocks I think will grow exceptionally, but for the most part I believe we are entering a bear market, and I have thus prepared myself with hedges.

The headlines, and the data and statistics that are coming in from Central banks and governments across the world are not exactly signaling optimism for the markets, yet the markets are trending towards all-time highs.

^SPX Chart

^SPX data by YCharts

I think it's absurd that the S&P 500 is approaching all-time highs, especially at a time like this. I will not go in depth as to why I think we are due for a major correction (again), but I will simply write a basic summary about why we are likely going to continue falling into a bear market, and about why investing in the VIX index might be smart.

The reasons for a bear market heavily outweigh the reasons for a bull market right now. Commodities have staged an odd recovery the past couple of weeks that hasn't exactly made much sense. Most importantly right now is the prices of oil; oil has proved to be latched on to the movement of stocks and vice versa.

Brent Crude Oil Spot Price Chart

Brent Crude Oil Spot Price data by YCharts

Brent crude oil has spiked over $10 USD in less than a couple months, but why? The world oil supply has remained at roughly 98 mb/d the past couple of months and demand has also been idle. I firmly believe oil will stage a recovery, but this recovery seems fake and is happening way too fast, which is alarming.

In addition to the suspicious rise in commodity prices, there is tons of debt everywhere. People are getting crushed by margin calls, people are still accumulating debt, and energy companies are on the brink of bankruptcies.

Banks are also having a hard time. Many major banks are hitting 52-week lows, although they have recovered slightly; but that point aside, they are still going to have to deal with lower interest rates. Nations around the world are following a general trend of lowering interest rates, even into the negative and this will likely hurt major bank stocks. Banks have also proven to be central to market crashes in recent history. It was a little surprising to see the markets react so positively to the Fed's latest press release. Yellen gave the people a lot of "ifs" and "buts" and "maybes", and I feel it did not justify the market spike we have just seen.

On top of all this, we are seeing a ton of political turmoil, which inevitably affects the markets. There are a lot of problems right now in the world: Brazil is on the brink of a political and economic collapse, Europe is dealing with the refugee crisis which in turn is giving right wing groups serious power and support, Brexit is a serious possibility and would have potential consequences on markets worldwide (and in my personal opinion the Brexit would negatively impact the world markets), and then there's the Middle East tension. I don't want this article to be a sensationalist piece, but there are a lot of similarities between what is going on right now and the 1930s.

Basically, I believe we are in for a roller coaster ride, and if there are people out there who are long on the markets as a whole, maybe a hedge or two would greatly benefit your portfolio.

The VIX index

The VIX is an index that uses options to predict stock market volatility, and it is commonly referred to as the fear gauge.

^VIX Chart

^VIX data by YCharts

As you can see from the chart we have had numerous spikes in a short span of time. The last time we've seen this type of market volatility was in 2011, and I believe this time there is potential for the volatility to be even greater.

Depending what market one invests in, it is entirely possible to put some money in an index that tracks the movement of the VIX. When the time comes for the market to crash, one's portfolio will be protected with a hedge in the VIX, but this is definitely a highly risky trade.

For example, Canadians, or those who invest in the TSX can invest in HVU. As I write this article the VIX is approaching lows it hasn't seen since early 2015, but I believe the market volatility has just begun. Catching the bottom of the VIX and riding it up during a major spike could be very profitable, but once again this is to be used as a swing trade, and the ETF should not be held for more than a couple of weeks at most.

Generally, I want readers to tread with caution in this current market environment. Everything seems off, and the markets are being irrational at the moment, thus a crash or a longer bear market might be in store for us. Hedging your portfolio is important, and remember to do your own research.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.