This complimentary article from Options Profits was originally published on September 19Options, Futures, Commodities... CLICK HERE to check out OP free for 14 days Russell Rhoads is an instructor with The Options Institute at the Chicago Board Options Exchange. He is a financial author and editor having contributed to multiple magazines and edited several books for Wiley publishing. In 2008 he wrote Candlestick Charting For Dummies and is the author of Option Spread Trading: A Comprehensive Guide to Strategies and Tactics. Russell also wrote Trading VIX Derivatives: Trading and Hedging Strategies using VIX Futures, Options and Exchange-Traded Notes. In addition to his duties for the CBOE, he instructs a graduate level options course at the University of Illinois - Chicago and acts as an instructor for the Options Industry Council. Over the past few weeks, CBOE Volatility Index (VIX) option volume has been very strong. Twice in September daily volume was over one million contracts, something that had only happened three times in the past. Tuesday, September 11, was a record volume day with 1,221,403 contracts changing hands. A major contributor to the continued growth in VIX option volume is the use of these contracts as an equity market hedge. Professional investors purchase out-of-the-money call options to hedge against a large quick down move in the stock market. his sort of strategy is now available to individual investors. A new and pretty innovative exchange-traded product that has a VIX hedging component built in was introduced late last month. The First Trust CBOE S&P 500 Tail Hedge Fund (VIXH) is an exchange-traded fund which has been created by First Trust Advisors. This fund was created to generate investment results that would mirror the performance of the CBOE VIX Tail Hedge IndexSM (VXTH). The CBOE VIX Tail Hedge Index is an index that tracks the performance of a strategy combining a portfolio that owns the S&P 500 Index with a small weighting in VIX Call options. The allocation to VIX Calls is based on market conditions on the day of monthly expiration. On that date, the weighting in VIX Calls is based on the opening price of the next expiring VIX Future contract. The weighting of VIX Calls is based on the following table:
The VIX Calls that are chosen would be the next expiring month call option that has a delta of 0.30. The price of these options is determined by the offer price at 10:00 am Chicago time on the day. Finally, the position in VIX Calls is not altered until expiration when the option positions are cash settled and a position is possibly established. Performance of VXTH is available going back to March 2006. The chart below compares performance of the VXTH Index and the S&P 500 Total Return Index. his comparison assumes $100 invested in both indexes in March 2006 and is held through the end of August 2012.
VXTH vs. S&P 500 TR