Volatility investors benefit from February market fall

WASHINGTON — Those who bet that the U.S. stock market’s fairly steady climb since last summer was too good to last were winners last month. Although the Dow Jones Industrial Average dropped more than 400 points Feb. 27, an index that measures market volatility skyrocketed that day. The Volatility Index, known as the VIX, had its largest single-day move since the Chicago Board Options Exchange began calculating it in 1993. It closed at 18.31, up 64% from the previous day’s close of 11.15. Huge volume The exchange also recorded its greatest volume of traded options based on the index that day. More than 6.7 million contracts were traded, about 1 million above the previous single-day high. “The VIX options buyers are betting on uncertainty in the market,” said Ben Londergan, the primary market maker for VIX options and co-chief executive of San Francisco-based Group One Trading LP. Volatility in the weeks following the February market fall has remained higher than recent levels. Over the five months leading up to Feb. 27, the VIX traded between roughly 10 and 12. The index, sometimes called the investor fear gauge, closed at 19.63 March 5. Last Tuesday, the VIX closed at 13.27. The index usually inversely tracks the Dow, making it a great hedge against drops in the U.S. equity markets, Mr. Londergan said. Technically, the index is calculated using the implied volatilities of a wide range of Standard & Poor’s 500 stock index options. On Feb. 27, there were two groups trading contracts based on the VIX, Mr. Londergan said. The first was mutual fund or hedge fund managers with long equity exposure in the market. This group took advantage of VIX options’ relatively good protection against a market crash, he said. The other group was speculators, who were trading options outright without a position in the overall market. These individuals had come into the market when the VIX was at historically low levels as a bet that it wouldn’t stay long forever, Mr. Londergan said. Despite gains that some investors saw from VIX investments in recent weeks, some financial advisers aren’t jumping to include this strategy in client portfolios. Some said they protect against losses in other ways. “We don’t pay too much attention to day-to-day moves,” said Ron Rutherford, chairman and chief executive of Asset Planning Inc., which is based in New York and Naples, Fla., and has about $130 million in client assets. “We encourage clients to look at a complete market cycle.” Mr. Rutherford combines as many as 20 different asset classes in each client’s portfolio, including some non-traditional assets such as preferreds, convertibles and direct real estate investments. At Schwartz & Hofflich LLP of Norwalk, Conn., advisers also depend on diversification in clients’ investments, according to adviser Ann Jevne. Additionally, the firm, which manages about $60 million in client assets, focuses on educating customers so they don’t panic with market swings, she said. No calls “We haven’t gotten any calls from clients worried about the late February drop,” Ms. Jevne said. The CBOE points to the results of a study it commissioned to show the value of investing in volatility. The study, completed by the Fund Evaluation Group LLC of Cincinnati and released March 2, looks at the effect of adding a portion of a portfolio to the CBOE DJIA Volatility Index, or VXD. Over the 109 months between October 1997 and November 2006, if a portfolio included about 10% in the VXD, it would have lowered the volatility of an all-stock portfolio about 26% without affecting returns, according to the study. The risk-adjusted returns actually would have increased for a stock-oriented portfolio that included 5% in the VXD index over that period, the report said. “Volatility as a tool for asset allocation is a concept worth considering because of the potential it has to improve the risk-adjusted returns of diversified portfolios,” said Michael Oyster, lead study consultant for the Fund Evaluation Group.