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 numbers for 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."

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