Updated Wednesday, April 16, 2014 as of 9:26 AM ET
Blogs - The Product Guru
Volatility Brings New Options For Investing—And New Challenges For Advisors
Bank Investment Consultant
Thursday, March 24, 2011
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Investment strategies ebb and flow in popularity. Through the 1980s and 1990s, buy-and-hold was the mantra. To be sure, some still espouse it, but others easily note that the overall markets have been flat for the past 10 years. And value investing was the main strategy for decades, until the growth guys decided they had a better way. Then the tech wreck made their new way look shortsighted.

In this changing landscape of investment trends, it seems that volatility is the new black. (Indeed, the argument that buy-and-hold hasn’t worked for the past 10 years isn’t that the market has been flat for 10 years, but rather that it has been herky-jerky around a flat trend line—in other words, volatility has been the overriding characteristic of the market). So selling at the right time has become a key point where most investors fail. And short of knowing just when to sell any given investment, diversification has become the best way to hedge against volatility. It still is, don’t get me wrong, but now there are also more ways than ever to invest in volatility itself.

In just the past couple of weeks, the Chicago Board Options Exchange has made a slew of announcements regarding new volatility-based investments. Specifically, it announced that it would apply its proprietary VIX methodology to six sector ETFs, including: iShares MSCI Emerging Markets Index Fund; iShares Trust FTSE China 25 Index Fund; iShares MSCI Brazil Index Fund; Market Vectors Gold Miners Fund; iShares Silver Trust; and the Energy Select Sector SPDR fund.

It also filed for approval with the SEC to list options based on new volatility indexes that track some individual stocks, also using its VIX methodology. The stocks are Apple, Amazon, Goldman Sachs, Google and IBM. If approved, the CBOE said that this would mark the first time investors are able to trade options based on the volatility of an individual stock. The same filing would allow investors to trade options on the CBOE Crude Oil ETF Volatility Index, essentially allowing investors to hedge the risk of volatility in the active oil sector for the first time, according to the CBOE.

And this is all just a couple weeks after it announced plans to start publishing a new index, the S&P 500 Skew Index, which is designed to be a measure of perceived risk of extreme negative moves, or “black swans.”

The CBOE created the VIX less than 20 yeas ago, and only began publishing values using the current methodology in 2003. But now it is making a push to export that methodology to other exchanges around the world. As part of that plan, it has formed a “VIX network” with exchange officials from around the world to promote VIX as the global standard for measuring volatility. It quoted Robert Shakotko, managing director at S&P Indices, in a recent press release: “The concept of measuring and trading volatility is still a relatively new frontier. Many exchanges around the world are contemplating or actively working toward establishing volatility indexes and volatility products in their respective markets.”

So the bottom line is that your clients will have more opportunities now to invest in volatility. And many will be interested. Indeed, as one indication of that interest, on March 15, the same day as many of the CBOE’s recent announcements, the number of VIX options traded topped one million, beating the previous one-day record in late 2009 by a whopping 44%.

One of the big advantages of volatility-based investing is the diversification it offers as these investments won’t be correlated with the broader markets. One of the big challenges, as always, will be general understanding and investor education. The concept of volatility and the notion of buying options are ideas that clients will need to get their arms around in the future. And in most cases, that education process will fall to the advisors.

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