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  • Noel Smith & Leo Capalleja

Is Volatility Performing in 2022?

Short answer: Yes, but less than you might guess. What has been working? Short stock and short puts.

The purpose of this paper is to point out what is possibly the largest outlier in asset class performance in 2022, the relative underperformance in volatility. Relative to the 5 previous -20% drawdowns in the S&P 500, tradable volatility as defined by the ETF, VXZ (4th through 7th month VIX futures) has underperformed by almost 50%. This along with other data presented in this paper will illustrate how and why hedges are massively underperforming.

Most investors diversify their portfolios to avoid large losses and, ideally, to benefit from uncorrelated positive returns. Traditional relationships between stocks, bonds, the US dollar, commodities and gold establish the foundations of most portfolio allocation strategies. One relationship that has been particularly reliable over many years is the inverse relationship between equities and volatility. In 2022, a year where almost everything (including historically negatively correlated asset classes) has gone down, volatility has gone up. However, while the relationship between equities and volatility is still “working”, volatility has not increased by the magnitude one would expect when using historical data as a guide.

Since VIX is not directly tradeable, for this analysis we will focus on actionable ETFs instead.

Here we look at the long short-term volatility ETF VXX (one-month VIX futures). Had an investor been long VXX in 2020 they would have been paid extremely well, but notice that with the similar recent drawdown in the S&P 500, VXX’s performance has been much weaker than before.

Here we see a similar picture for mid-term volatility using the ETF, VIXM (4th through 7th month VIX futures). Again we see large underperformance in 2022 relative to 2020.

Here we compare 3 ETFs: SPY (S&P 500), VXTH (S&P 500 with a long VIX tail-hedge) and PPUT (S&P 500 with a long put option hedge). Note the large increase in the top brown line (VXTH) in 2020 that demonstrates the extreme value-add of having a volatility hedge.

Here is the same data with the year, 2022, highlighted. Note that the hedged positions are down with a current SPY drawdown of about -20%.

Using the mid-term long volatility ETF, VXZ (fourth through seventh-month VIX futures) we see extremely similar results. Note that this analysis uses extrapolated historical data since VXZ was created by Barclays in 2018. During the GFC volatility was extremely responsive…but not at first. In the chart below we can see that volatility was initially slow to respond during the GFC and did not “pop” until after a large drawdown in the second half of 2008. Then it exploded.

Equities tell only one part of the story. Bond volatility is also highly relevant. Here we see the MOVE index (roughly a VIX for bonds). It is at levels not seen since the GFC.

The main takeaway is that both the magnitude and speed of a market move are very important. It's not just the fact that the S&P 500 is down -20% that matters, but how long it took to get there matters just as much if not more. In other words, the path matters when it comes to volatility.

Using the above chart from the GFC we can see that volatility did not explode higher until the second “leg” of the crash. If what is past is prologue then we might not get that volatility explosion in 2022 until (and if) the S&P 500 goes significantly lower.

So what is the trade from here? If investors want to have a hedge, put spreads or other less risky relative value trades seem more prudent than just outright puts. We think being long SPX 3000 naked puts or other similar far out-of-the-money trades are likely to fail.

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