Steve:Regarding your column about the new volatility futures, I know you didn't do the study, but is it valid? Did the simulated portfolio really have an outperformance average of 5% more a year with an average 25% drop in volatility, or were those numbersfor the best year? It sounds too good to be true!-- S.

Last week's

article on VIX futures made mention of a Merrill Lynch study that concluded a "simulated portfolio comprised of 10% VIX and 90%

S&P 500

stocks outperformed the index every year since 1986 by 5%, while cutting the risk by 25%." The results represent the yearly average over the life of the study. Because it uses back data starting in 1986, it obviously includes the crash of 1987. That year, the S&P fell 28%, but the 90/10 portfolio actually produced a 20% gain. This causes something of a skew in the results, which made my subsequent statement -- "this negative correlation works best when there is a dramatic drop in price" -- something of an understatement.

Still, even if you exclude 1987, the study demonstrated an annual outperformance of nearly 2%, with about 21% less volatility.

A similar, if more basic, study done by Larry McMillan, president of McMillan Analysis, uses data from 1993 through February 2004. It shows the 90/10 portfolio's total returns were about 2.5% lower than the S&P 500 during that time period. But the hedged portfolio did indeed have about 19% less volatility than the S&P alone.

But it's important to note that these studies are based on owning the VIX itself, not a futures contract. As I mentioned, the futures will most likely trade at a premium above the VIX (although if the VIX ever gets back up to truly extreme levels, later months will likely trade at a discount); since there is no data on historical futures prices, it couldn't be factored into the studies. Any premium placed on the futures contracts will increase the cost, causing a drag on performance and possibly diminishing the efficiency of the hedge.

Steve: Where can I find options on the SOX index? Thanks, -- J.

Options on the Philadelphia Semiconductor Index (SOX) can, believe it or not, be found and traded on the

Philadelphia Stock Exchange (PHLX). Here's a link to the

SOX option page. These options also trade at the Chicago Board of Options Exchange. You should be able to access prices and the full option chain from your online broker or trading page, or various Web sites -- for example,

go here for the CBOE's quotes by simply typing in "SOX."

Steve:What is the advantage of shorting common shares against calls to lock in a profit? Why not simply sell a partial position of the calls? -- G.L.

The benefits of shorting stock against calls is that it keeps the full position open and provides the possibility of making many short-term trades at no additional risk.

For example, assume XYZ is trading at $48, and two weeks before expiration you buy 10 of the $50 calls at 25 cents each for a total cost of $250. Over the next few days XYZ rises to $51 (let's say there was a good earnings report), and the value of the calls climbs to $1.50. You could sell the calls for $1,500 and pocket a $1,250 profit, or you could short 1,000 shares of XYZ at $51, which locks in a $750 profit but keeps the position open.

If XYZ falls back to $50, the 1,000 shares of short stock could be bought to cover, securing a $1,000 profit. But you'd also still own the 10 call options, which, depending on time remaining and other variables, will still have some retained value. (Assuming there's a week remaining and 24% implied volatility, the calls would still have theoretical value of about 60 cents, or $600 for the 10-contract position.)

At this point, you could sell the calls and realize a total profit of $1,350 or retain the long call options, wait for a rally in XYZ and re-short some common stock again. This is the real key: The process of shorting the shares (and covering for a profit) can be repeated as many times as XYZ moves above $50 and back down prior to the calls' expiration. Of course, this could be done by shorting just 500 shares (or any amount below 1,000) to create risk-free, short-term trading opportunities and maintain upside potential through the calls held net long (that don't have an offsetting short common-share position).

This works because an option's delta (the rate of change in an option's price relative to the change in price of the underlying) is sloped. As an option moves deeper into the money, its price will begin to correlate on a dollar-for-dollar basis with the underlying stock. And the reverse is true as an option moves out of the money -- its price would fall less than a declining underlying stock.

By shorting the common stock, you're able to capture the full amount of a price decline, rather than an incremental change in the option's price. Also, because of the greater liquidity and tighter bid/ask spreads, it's simply much easier -- in a short time frame -- to trade in and out of a stock for relatively small price movements than it is to "scalp" options.

While shorting common stock against calls is something that Jim Cramer often suggests as a follow-up to one of his successful call-buying recommendations, there is nothing wrong with simply selling out the calls, taking your profits and moving on to the next opportunity.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to