Friday, January 11, 2013

Go Long Volatility

I continually search for asset classes or specific investments that are depressed in price, unpopular, or undervalued based on asset values or cash generation.

After major global stock indexes returned more than 16% (including dividends) and almost 4% more so far in January, there are few depressed assets or instruments.  Earlier this week I identified gold and gold stocks as providing such an opportunity.  

Now I think volatility is another opportunity.  There is a high level of complacency, if not outright ebullience, among investors now.  This is reflected in the extraordinarily low level of the VIX index of volatility on options linked to the S & P 500 stock index.  

High levels of the VIX Index are historically reliable indicators to buy stocks, since the expectation of high volatility in stock prices reflects anxiety (and is a contrarian indicator to buy).  The evidence supports buying stocks when the VIX Index is above 30.

Low levels of the VIX, on the other hand, do not have the same empirical support as a market timing tool (in this case as a sell signal).  Yet, the current level of 13.5 on the VIX is exceptionally low and, I think, worth "buying."  There are several exchange traded funds that are linked to the VIX Index (such as VIXY).  These instruments are not appropriate to buy and hold, as they tend to erode over time when held indefinitely.  But at current prices, I think they are a worthy speculation and a way to hedge core stock holdings against a broader market decline.

Steve Lehman

S & P 500:  1470
VIX:  13.5

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