Volatility Trading May Mean Profit in 2004

Tracking Performance, Creating Comparisons and Correlations

Last year, FIMAT Global Fund Services began construction of its Financial Volatility Arbitrage Mediam index (FVAM) to track the performance of funds that use volatility-based strategies. According to Dr. Rami Habib, a quantitative analyst at FVAM, the index [it currently consists of just five funds, and WP Capital is not one of them] is in its early phases, "but the ultimate goal is to compile data that provides a comprehensive understanding of the return characteristics of volatility strategies." He hopes the index will divulge the correlation of volatility to the overall market and provide a format for comparing relative performance among volatility-based strategy funds. Since its January 2003 inception date, the cumulative return of the five funds that comprise the FVAM index was -6.4%.

Knowing that volatility strategies produce noncorrelative returns relative to stocks or other asset classes, such strategies can be better applied as part of an overall investment portfolio. The real value of the index will be "to get people starting to look at volatility as an asset class," said Habib.

Habib thinks the CBOE's proposed plan to trade futures and options contracts based on the VIX will make volatility trading more efficient and therefore a growth category. "I believe that once we've gone through another period of expansion and contraction in volatility, that volatility as an asset class will be considered part and parcel of everyone's allocation," said Donald Dale, chief strategist and volatility trader at TF Asset Management. While volatility funds are few in number and are often lumped into the market neutral or long/short, having a benchmark such as the FVAM index should help define and expand the universe.

In the short term, individual traders and money managers that employ volatility strategies are hoping the VIX's recent gain to 17.8% over the last eight trading days is a sign that the expansion has finally arrived. And not to throw good money after bad, but if you survived the great VIX drop of 2003, the current levels would imply that the risk/reward ratio is in favor of employing strategies that would benefit from a rise in market volatility.

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