Low Volatility Levels Provide Hedge Opportunity at Discount Rates

 

Education is the ability to listen to almost anything without losing your temper or your self confidence.” – Robert Frost

 

Right now, it looks like it would take a major downside event to prevent the major indices from having a swimmingly good year.

And, with December historically being one of Wall Street’s best months, the U.S. and Iran suddenly playing nice, and the next Washington budget battle still a shout away, odds are that the current uptrend will continue, at least into the New Year.

It doesn’t seem like a stretch to make such a prognostication, really, given that the benchmark S&P 500 Index (SPX) hit an all-time high of 1,800 last week as it notched its seventh straight week of gains.

Ditto for the Dow, as the Dow Jones Industrial Index (DJIA) soared above 16,000 towards the end of the week, once more hitting its own record highs. Like the SPX, the Dow has been in the black for the last seven weeks, a fairly robust uptrend to be sure.

Attributing the market’s direction solely to the Fed’s continued largesse, in the form of its $85 billion per month bond purchase program, would be an over simplification, of course, though it does seem that the market’s uptrend gets substantially slowed every time the various and sundry Fed officers mouth the word “taper.”

No, it would seem that the lack of any really bad economic news, coupled with the fact that investment capital currently accepts the risk inherent in equities, combines for a powerful one-two punch that apparently trumps the nation’s actual economy, which remains in the realm of extremely low growth.

Volatility is low, and complacency is high.

So is there some play that may be made in terms of volatility? Probably, though the play may consist primarily as a hedge.

Using the Chicago Board Options Exchange Market Volatility Index (VIX) as a proxy for volatility, the “fear gauge” as it is known, reveals some interesting patterns for this calendar year.

Closing at 12.26 as of Friday, the VIX is in familiar territory for 2013. It has now hovered at or near 12 during four distinct time periods this year, a level similar to that seen prior to the 2008 crash. Each time, it then soared by 25% or greater within the following couple of weeks.

For the last month, the VIX has been restrained to a band ranging from 12 to 14, a relatively tight range for the volatility gauge. It might not be much of a surprise to see it break out of this sideways pattern in the near future.

Since you can’t trade the VIX directly, the VXX (S&P 500 VIX Short-Term Futures ETN), which tracks the S&P 500 VIX Short-Term Futures Index, can be used. While being an inefficient tool for long-term hedging, VXX remains better suited and more effective as a short-term hedge.

With the VIX capable of shooting up 30 – 40% in just a couple of days in response to fast-shifting market momentum, the value of holding some volatility as an asset class should be evident.

With a complacent market like the one currently in place, and with the VIX hitting a level that has served throughout the year as something of a “bouncing point,” the VXX play is certainly worth a glance to “gauge” its value.

What The Periscope Sees

The Sabrient SectorCast ETF Rankings rate each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score and is revised on a weekly basis.

The Financial Sector continues its reign in the top spot, with an Outlook score of 84. The Technology Sector, which has held the top spot for a good portion of the year, is rising once more, with a score of 77.

The Consumer Goods Sector, currently in third place, stands a chance of gaining ground should Black Friday post some impressive numbers.

Among the Financial Sector ETFs, here is a list of some of the top performers year-to-date. The list is current as of the third week of November:

KIE — SPDR KBW Insurance ETF, +41.52

FXO — First Trust Financial AlphaDEX Fund,  +36.44%

XLF — SPDR Financial Select Sector Fund, +31.12%

IYF — iShares Dow Jones US Financial Sector Index Fund, +29.64%

VFH — Vanguard Financials Index Fund, +28.56%

ETF Periscope

Full disclosure:  The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Daniel Sckolnik or Sabrient. Neither Daniel Sckolnik nor Sabrient makes any representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

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