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Because VIX calls are based on VIX futures instead of the more volatile "spot" VIX, in the past I suggested that it would be easier to hedge a portfolio against a "black swan" stock market decline using S&P 500 puts-either the cash-settled SPX index puts or the equity-settled SPY ETF puts.

Well, I stand corrected. In preparing for a conference down in beautiful Palm Beach, Florida, I read two academic studies-one published in 2009 and another published in 2012-that found VIX calls to be a much more effective portfolio hedge than S&P 500 puts. The reason is that most institutional investors (including mutual funds, hedge funds and pension funds) are benchmarked against the S&P 500 and have historically hedged their portfolios almost exclusively by purchasing S&P 500 puts. This institutional buying pressure has bid up their prices dramatically and made S&P 500 puts very expensive hedges for the rest of us. The more expensive a hedge, the less effective it is. By contrast, VIX calls have only been around since February 2006 and have yet to be widely adopted by "big money" institutions. Consequently, the prices of VIX calls have not been bid up by institutions and remain reasonable.

In the 2009 study, Exhibit 12 on page 19 and Exhibit 15 on page 22 show the great portfolio hedging effects from allocating a small percentage (1 percent or 3 percent) of portfolio value to VIX calls. Calls that expire in one month are purchased and rolled every month. The study looked at two different strike prices for VIX calls: (i) at the money (ATM); and (ii) 25 percent out of the money (OTM). What constitutes ATM and OTM is based on VIX futures expiring at the same time as the VIX calls. For example, "at the money" and "25 percent out of the money" for a VIX call that expires in June would be based on the 21 percent level of the June VIX futures (VIX/M2) and not the 19 percent level of the spot VIX.

What's amazing is that adding VIX calls to a stock portfolio increases returns and reduced volatility-the best of both worlds. The study looked at two time periods, one longer term and one shorter term: (1) a nearly two-year period between March 2006 and December 2008; and (2) a five-month period during the market crash of 2008. In both cases, adding VIX calls substantially outperformed the S&P 500, while similar allocations to S&P 500 puts underperformed the S&P 500 over the longer term and only slightly outperformed over the shorter term:

March 2006 to December 2008

Portfolio Allocation

Rate of Return

Standard Deviation (i.e., volatility)

Maximum Drawdown

100% S&P 500




99% S&P 500, 1% ATM VIX Calls




97% S&P 500, 3% ATM VIX Calls




99% S&P 500, 1% 25% OTM VIX Calls




97% S&P 500, 3% 25% OTM VIX Calls




99% S&P 500, 1% ATM SPX Puts




97% S&P 500, 3% ATM SPX Puts




August 2008 to December 2008 (Market Crash)

Portfolio Allocation

Rate of Return

Standard Deviation (i.e., volatility)

Maximum Drawdown

100% S&P 500




99% S&P 500, 1% ATM VIX Calls




97% S&P 500, 3% ATM VIX Calls




99% S&P 500, 1% 25% OTM VIX Calls




97% S&P 500, 3% 25% OTM VIX Calls




99% S&P 500, 1% ATM SPX Puts




97% S&P 500, 3% ATM SPX Puts




For the longer time period, a 3 percent allocation to 25 percent OTM VIX calls performed the best, transforming the S&P 500's 10.3 percent loss into a 1.2 percent gain. But that performance incurred greater volatility, so you had to have the fortitude to endure the allocation's temporarily deeper drawdown. By contrast, a 3 percent allocation to SPX puts was a disaster, tripling the S&P 500's loss to -30.85 percent and incurring higher volatility to boot-the worst of both worlds. For the shorter period encompassing the five months of the 2008 market crash, both VIX calls and SPX puts outperformed the S&P 500, but the VIX calls actually caused the overall portfolio to gain, whereas the SPX puts experienced losses, albeit smaller losses than an equities-only portfolio. For another strategy that minimizes risk and increases returns, check out my article, The Greatest Anomaly in Finance: Low-Beta Stocks Outperform.

The 2012 study evaluated the performance of the Chicago Board Options Exchange's (CBOE) "VIX Tail Hedge Index" (^VXTH). The index is comprised of the S&P 500 and a dynamic allocation to one-month VIX calls varying from 0 percent to 1 percent, depending on the likelihood of a market crash as measured by the price level of near-term VIX futures. Studies have shown that market crashes are extremely unlikely when the price level of VIX futures is below 15 or above 50 and are most likely when VIX futures are between 15 and 30. Consequently, the index has a 0 percent allocation to VIX calls when VIX futures are below 15 or above 50 and a 1 percent allocation when VIX futures are between 15 and 30. A middle-of-the-road 0.5 percent allocation to VIX calls occurs when VIX futures are between 30 and 50. By not purchasing VIX calls during "safe" periods, hedging costs are substantially reduced.

The VXTH index has outperformed the S&P 500 index by a significant margin (almost five times larger) over the past six years:

VXTH vs. S&P 500








Total Return









S&P 500








During October 2008-the worst month of that year's market crash-the VXTH index actually gained 6.1 percent compared to the S&P 500's 16.8 percent loss.

To determine the number of 30-delta VIX calls to purchase, perform the following steps:

  1. Multiply the per-unit price of the VIX call by 100 to get the value of one option contract.
  2. Divide the option contract value into the dollar value of your stock portfolio.
  3. Multiply this number by 1/99 (i.e., 1.0101 percent) (this assumes you keep your stock portfolio intact and buy the VIX calls with new money).

So if your S&P 500 stock portfolio is worth $100,000 and the VIX June $26 call (i.e., the 30-delta call) is trading at $1.40 per unit ($140 per contract), then the number of VIX calls to buy is:

($100,000/$140) * 1.0101% = 7.2

Since you can't buy fractions of a call, you need to round down 7.2 contracts to 7 contracts.

For a 3 percent VIX allocation, the multiple in Step No. 3 would be 3.09 percent instead of 1.01 percent because the fraction is now 3/97 instead of 1/99. Consequently, the number of VIX calls for a 3 percent allocation would be:

($100,000/$140) * 1.0309% = 22.1 contracts (22 rounded down).

Both the 2009 and 2012 studies assume that your stock portfolio is the S&P 500, but in reality most investors' stock portfolios differ from the S&P 500. Consequently, the 1 percent allocation to VIX calls discussed above needs to be adjusted to accurately reflect the difference between the S&P 500 and your portfolio. The way to do this adjustment is by measuring your portfolio's "beta," which measures both the correlation and magnitude by which your portfolio's value moves with changes in the value of the S&P 500 index.

In a recent article I wrote for my options advisory service, Options for Income, I described how to calculate the beta of the OFI portfolio, and the same method can be used to calculate the beta of your personal portfolio. All you need to do is take the percentage of your portfolio allocated to an individual stock and multiply that percentage by the stock's beta. Repeat the process for each stock and then add all the numbers together to get the portfolio's beta. A simple $100,000 five-stock portfolio illustrates the point:

Calculating a Portfolio's Beta


Dollar Amount

Percentage of Portfolio


Dollar-Weighted Beta

United Therapeutics(UTHR)










Autodesk (ADSK)





Gold ETF (GLD)





General Electric(GE)










The portfolio beta of this fictional stock account is 1.08. If you were planning on adding a 1 percent allocation to the VIX June $26 calls discussed above, you would take the 7.2 number calculated above based on an S&P 500 portfolio and multiply it by 1.08. The result is 7.8, which rounded up equals 8 VIX calls. So you would buy one extra VIX call to take into account the fact that your portfolio is slightly more volatile than the S&P 500.

Easy enough, right?

If you want to batten down the hatches and completely hedge your portfolio from a market downdraft, there is another way to calculate the number of VIX calls to purchase by using a method that is not based on a fixed 1-percent or 3-percent allocation. This second method is based on the calculation used to determine the number of SPY puts needed for complete downside protection of your portfolio.

The procedure for calculating the number of SPY puts is as follows:

  1. Divide the dollar value of your portfolio by the SPY value and multiply by 100
  2. Multiply the resulting number by your portfolio's beta to get the number of at-the-money puts needed for complete downside protection.

For example, if your portfolio is worth $100,000, has a beta of 1.23, and SPY is trading at $136, the number of SPY puts needed to hedge completely is 9:

[$100,000/ ($136*100)] * 1.23

To convert nine at-the-money SPY puts into an equally effective number of at-the-money VIX calls, you need a conversion ratio. As a rough rule of thumb, Larry McMillan says you need about two VIX calls for every one SPY put (slide 54). But the precise conversion ratio is based on the following formula:

(SPY volatility * SPY price)/ (VIX futures volatility * VIX futures price)

VIX June futures are 21 with a volatility of about 85 percent annualized and SPY is 136 with a volatility of about 20 percent annualized. Consequently, the VIX call/SPY put conversion ratio is currently:

(20*136)/ (85*21) = 1.5

So instead of buying nine at-the-money SPY puts, you could buy 14 at-the-money VIX calls (9*1.5).

Bottom Line

Personally, I prefer the CBOE's VXTH index approach, which limits the VIX call hedge to a 1 percent allocation during the danger-zone time periods when VIX futures are between 15 and 30. It won't completely protect against a "black swan" market decline (the VXTH index lost 19.3 percent in 2008), but it significantly outperforms the S&P 500 over time, and that's the type of long-term wealth-building I'm most interested in generating. For more options strategies, check out my free Options Trading Strategies report.

Happy hedging.

Source: Buying VIX Calls As A Portfolio Hedge