This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration. Need a new registration confirmation email? Click here
NEW YORK ( TheStreet) -- First Trust CBOE S&P 500 VIX Tail Hedge Fund(VIXH) began trading Thursday. The underlying CBOE VIX Tail Hedge Index is based on the S&P 500 and an amount of one-month call options on the CBOE Volatility Index(VIX) ranging from 0% to 1% of the portfolio. The exact amount is determined by the level of forward volatility.
"Black swan" events
are defined to be those that are both a surprise and have a major impact.
In statistical terms, they are often referred to as
(three standard deviations) events, and more recently the term "tail risk" has been used in financial circles.
VIXH's objective is to hedge away the tail risk of equity exposure. According to the
VIXH overview page
, on the day of the monthly expiration of VIX options, previously purchased VIX calls are cash-settled and new VIX calls are purchased by the index at the 10:00 a.m. Central Time asking price. The percentage of money allocated to VIX calls depends on the level of forward volatility of the S&P 500 at the next call expiration as measured by the opening price of VIX futures with the same expiration as the calls as follows:
VIX futures less than or equal to 15, no VIX calls are purchased
VIX futures above 15 and less than or equal to 30, 1% of portfolio in VIX calls
VIX futures above 30 and less than or equal to 50, 0.50% of portfolio in VIX calls
VIX futures above 50, no VIX calls are purchased
The dynamic allocation to VIX calls is designed to reduce hedging costs by limiting the number of VIX calls that are purchased during periods of expected low volatility. It also has the effect of taking VIX option profits when extreme volatility levels are reached.
VIXH is holding all 500 stocks of the S&P 500, in the appropriate allocations. The new ETF has an expense ratio of 0.60%, and additional information is located in the
Analysis/Opinion: I have long held the belief that exposure to the VIX provides an excellent way of reducing risk in an equity portfolio, and addressed that topic in my 2009 article
New ETNs Allow You to Buy Volatility: VXX, VXZ
Unfortunately, no products are available that track the VIX. Instead, traders and investors must be content with VIX futures and options, which have their own unique characteristics. The new VIXH uses VIX call options.
With an upper range of 1% per month, the performance impact of constantly hedging at the maximum level could be significant. In order to potentially control hedging costs, the underlying index and VIXH reduce hedging to 0.5% when the VIX is between 30 and 50. Additionally, no hedging is used when VIX is below 15 or above 50.